Power of Buffett
When I originally started to write this particular column, I had envisioned taking on the venerated Warren Buffett and his stance on corporate repurchases. Disagree with Warren? Blasphemous for sure but I felt I had a good bone to pick with him and his opinion on corporate buybacks.
I really haven’t changed my mind about this practice. While it, at the end of the day, does add shareholder value to the companies that are participating, it doesn’t move the needle as far as corporations building for the future.
A company that spends 1.5 billion dollars a year repurchasing shares is not spending it upgrading healthcare for it’s workers or spending it on research and development. It is just increasing shareholder value at theoretically the lowest cost possible.
The real thorn in my side is that these buybacks have a very positive effect on C-Suite compensation packages. Those packages are generally tied to stock performance and what better way to increase stock performance than implement a corporate repurchase program. Is the company in better financial shape than before these buybacks? I say a strong argument can be made for no.
But Warren thinks people like me are ignorant. Well, he is the greatest investor in the history of mankind so who am I to argue with him? Let’s just say I believe that people who want to forgo a corporate buyback and use that money to buy a competitor and create a wider moat for their own company have a legitimate strategy as well.
Yet, now, after reading his letter to shareholders for the third time I am not so sure that Mr. Buffett is wrong. He lays out his reasoning in a simple, straight forward way and I can see his point.
Because Berkshire Hathaway is the ultimate long term investor, they have the unique ability to buy very high quality names and hold them for a very very long time. This super long term approach and their ability to invest with both pockets gives them the freedom to encourage corporate repurchase programs because they have already decided that the name they have invested in has a long term sustainable business model and tremendous cash flow. Those two things allow for substantial buyback programs. A company that has 7 or 8 billion dollars in profits yearly can still spend on benefits and spend on research while still having enough cash to implement that buyback.
I get it.
What I don’t get is corporations that are in competitive industries and a shorter time frame model using buybacks to bolster share price. It is cash that could be better used for increasing marketshare, buying smaller competitors and developing new products. Those are the companies that I rail against.
Buffet has not bought any small cap stocks in a very long time. When you have billions to invest and your model is buy high value, big name companies that fit within your business model, it’s easy to agree that buybacks are good. Simply put, the buybacks help his portfolio companies increase share value. There is nothing wrong with that and I applaud him for coming out and spilling one of his secrets but for the 90% of the companies that don’t fit his investment model, I am not so sure that this is good for the growth and sustainability of many of those companies.
The important thing though is that most companies that have these buybacks in place don’t overdo it. While it is great for shareholders it may occasionally put companies in a bind as far as building out their businesses. Generally, companies will reach into the debt markets to finance certain obligations but as interest rates rise, that might be just too expensive and they may decide to forgo those repurchase programs until the business environment becomes more friendly. The sad thing about that is that those suspensions usually happen when stocks are their cheapest and a buyback would actually have a much greater impact on shareholder value.
There is obviously a case to be made on both sides and given Buffet’s track record most people will agree with him. Given his investment model, it works to his advantage to have these buybacks in place. As a matter of fact, pretty much any investor will tell you they love having buybacks in place. They believe that there company is working to increase shareholder value and I suppose that is true in a fundamental sense but there are two types of managements, one that is lazy and has no creativity and one that is looking to grow the business in unique ways with unique ideas and products. I am not Warren Buffett and I look to the latter.