In the world of investing, few names hold the weight and respect that Warren Buffett does. His conglomerate, Berkshire Hathaway is not just a business powerhouse; it’s a beacon of wisdom and strategy in the investment universe. Warren Buffett shares pearls of wisdom in his Annual Shareholder letters. This blog dives deep into a few topics covered in those letters.
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Share Repurchases: A Strategic Approach
Warren Buffett has extensively addressed the topic of Share Repurchases (Buybacks) across his letters, providing valuable insights. Within these letters, he imparts a distinct set of guidelines that offer a comprehensive framework for companies to navigate and make informed decisions regarding this matter.
Views of Warren Buffett
Companies should proceed with share repurchases judiciously, adhering to specific conditions:
- Firstly, an essential prerequisite is for the company to possess available funds, including cash and sensible borrowing capacity, that surpass immediate business needs. This financial cushion ensures a stable foundation for engaging in repurchases.
- Secondly, the decision should hinge on the stock’s market performance, trading below its conservatively-calculated intrinsic value. This parameter guarantees that repurchases are conducted when the stock is undervalued, thereby maximizing shareholder returns.
- However, a pivotal aspect lies in providing shareholders with unfettered access to all requisite information to accurately gauge the stock’s intrinsic value. This transparency prevents insiders from exploiting uninformed shareholders by purchasing their shares at a fraction of their actual value – an occurrence witnessed occasionally.
Berkshire Approach to Repurchase
Berkshire Hathaway follows a distinct approach:
- Under this approach, share repurchases are undertaken exclusively when the stock exhibits substantial undervaluation in comparison to its intrinsic value, conservatively calculated.
- The company refrains from any attempts to artificially manipulate the stock price, ensuring fairness and integrity.
- Instead, a commitment is made to furnish all shareholders, existing and potential alike, with the same valuation-related information. This equitable dissemination guarantees that the decision-making process surrounding repurchases is well-informed and unbiased.
When does Repurchase benefit?
Consider this analogy: In a business worth $3,000 with three equal partners, if one partner is bought out for $900, the remaining partners each gain $50. But if the exiting partner is paid $1,100, the continuing partners each incur a loss of $50.
Circle of Competence: Staying True to Expertise
Warren Buffett acknowledges that predicting the long-term economics of businesses in rapidly evolving sectors is beyond his scope.
“If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter. Predicting the long-term economics of companies that operate in fast-changing industries is simply far beyond our perimeter. If others claim predictive skill in those industries — and seem to have their claims validated by the behavior of the stock market — we neither envy nor emulate them. Instead, we just stick with what we understand.” – BRK Shareholder Letter 1999.
“It’s vital, however, that we recognize the perimeter of our “circle of competence” and stay well inside of it. Even then, we will make some mistakes, both with stocks and businesses. Most investors, of course, have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power.” – BRK Shareholder Letter 2013.
Businesses – The Great, the Good, and the Gruesome
Warren Buffett categorizes businesses into three distinct types: Great, good, and gruesome. This idea was shared in his 2007 Shareholder letter.
This is a wonderful way to classify business and helps investors choose great/good business while ignoring gruesome business. I would also suggest to read my earlier blog, where I have covered this topic in depth.
Great Business
In the realm of capitalism, competitors will invariably challenge any business yielding high returns. Capitalism’s concept of “creative destruction” benefits society, but it eliminates investment predictability.
- Possesses an enduring “moat” that safeguards substantial returns on invested capital.
- The criterion of “enduring” excludes companies in industries susceptible to rapid and constant change.
- A moat that needs continual reconstruction will eventually cease to be a moat.
- This criterion eliminates businesses reliant on an exceptional manager for success.
- If a business’s exceptional results hinge on a superstar, the business itself can’t be categorized as exceptional.
- A striking analogy to illustrate this… While a top brain surgeon might enjoy substantial and growing earnings, this doesn’t guarantee the future – once the surgeon departs, the moat disappears.
Essential barriers are being a low-cost producer or holding a robust global brand (such as Coca-Cola, Gillette, American Express) is crucial for sustained success.
Another crucial distinction is that these businesses do not need huge capital for growth.
Good Business
They are excellent, but not extra ordinary business. Utilities fall squarely in this category. We will earn considerably more money in this business ten years from now, but we will invest many billions to make it.
Gruesome Business
The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.
How We Think About Market Fluctuations
Berkshire Hathaway’s outlook on market fluctuations challenges conventional thinking. It highlights the common misconception of investors rejoicing over rising stock prices even when they’re net buyers. Berkshire’s perspective suggests that only sellers should celebrate such gains, while purchasers should prefer lower prices.
Below are his views in 1997 Shareholder letter:
“A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
So smile when you read a headline that says “Investors lose as market falls.” Edit it in your mind to “Disinvestors lose as market falls — but investors gain.” – Warren Buffett
Conclusion: Insights for Investors
This and the last two blogs cover the learnings that I had from the Berkshire Hathaway Shareholder letters. This brings an end to the topics around Warren Buffett and Berkshire Hathaway.
Hope you found this blog useful. Do share my blogs with your friends, peers and fellow investors.
