Buffett Sending Wrong Message

September 26th, 2011 by hackel Leave a reply »

 

If Warren Buffett wanted to send a message that stocks, including that of Berkshire Hathaway, were undervalued, he should have announced a series of acquisitions across a spectrum of industries.

By doing that he could have both improved the lot of Berkshire shareholders by improving its return on capital, free cash flow and financial structure, and that of consumer and investor confidence, in general.

Through announcing the possibility of large share repurchases, he is doing the opposite. Giving cash to shareholders who want out the door does not create a penny of cash flow,  cost of capital or the spread between the two, although it does aid GAAP based metrics. Although Berkshire does not grant stock options to executive officers, many firms do indeed benefit from improvements to GAAP as it is used in many plans determination of compensation.

Berkshire, despite the large cash hoard appearing on its balance sheet, needs to preserve cash. To begin, it does have $59 billion in debt. In addition, it has liabilities to insured’s, both present and to come, especially as management does take risk which many competitors do not. Also, Berkshire has $35 billion in notional value in put contracts ( a bullish market play) which increased by $1.2 billion thru June 30th, and is obviously quite a bit higher today given the downfall in stocks since.  Although these a are long term contracts, the liability is real and could be significant, not something credit rating agencies like to see. Nor do they like to see depleting equity, which is the direct result of share buybacks.

I believe, the announcement out of Omaha today is more a reflection of Mr. Buffet’s age then an endorsement of share buybacks. Is there any doubt Berkshire has built value through capital acquisition and resultant free cash flows, rather than share repurchases?  Investors have bought stock in the company over the years due to Buffett’s keen analytical ability in building capital-share buybacks destroy it.  In fact, if other firms were to follow suit, given the economic slowdown, many would find themselves in a position similar to 2008.

 

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