Warren Buffett wants to convince you stock buybacks are not the enemy.
Over the past few years, prominent investment managers have decried the overuse of buybacks — in which a company buys its own shares — as the peak of short-term capitalism. Critics say they focusing on a near-term boost for shareholders over investments in assets that might yield long-term profits.
Even Larry Fink, the CEO of the world’s largest asset manager, BlackRock, has taken companies to task in over-using buybacks in his last two letters to the CEOs of the S&P 500 companies.
In his 2016 Annual Letter to Shareholders released Saturday, the Berkshire Hathaway CEO, however, wrote that he believes that these repurchases are a fair use of capital and that no company has forgone a long-term investment to buy back its shares. From the letter (emphasis added):
“As the subject of repurchases has come to a boil, some people have come close to calling them un-American — characterising them as corporate misdeeds that divert funds needed for productive endeavours. That simply isn’t the case: Both American corporations and private investors are today awash in funds looking to be sensibly deployed. I’m not aware of any enticing project that in recent years has died for lack of capital. (Call us if you have a candidate.)”
There has been a noticeable increase in buybacks. According to HSBC, US companies bought back $US2.1 trillion of their own shares between 2010 and 2015, and buybacks have recently hit record levels.
To Buffett, this is simply a fine use of a company’s capital and still rewards shareholders over the long-term. There are some exceptions for Buffett. The legendary investor believes that too often companies have engaged in buybacks for buybacks sake and “repurchases only make sense if the shares are bought at a price below intrinsic value.”
“When CEOs or boards are buying a small part of their own company, though, they all too often seem oblivious to price,” Buffett wrote in the letter. “Would they behave similarly if they were managing a private company with just a few owners and were evaluating the wisdom of buying out one of them? Of course not.”
Put another way, companies should have a target price at which they buy back their own stock — not a total amount to buy regardless of price.
Additionally, Buffett said there are two instances a firm should never do buybacks: when the company needs the capital for long-term investments and when the company needs capital for an acquisition.
These ideas on buybacks are long-held for Buffett, who has always seen the value in repurchases and has done so with his own firm frequently. in fact, Buffett said in the letter that buybacks for Berkshire are becoming harder to execute.
“To date, repurchasing our shares has proved hard to do,” wrote Buffett. “That may well be because we have been clear in describing our repurchase policy and thereby have signalled our view that Berkshire’s intrinsic value is significantly higher than 120% of book value. If so, that’s fine.”