Please ensure Javascript is enabled for purposes of website accessibility

Why Warren Buffett Won't Support David Einhorn's Plan at GM

By Adam Levine-Weinberg - Apr 23, 2017 at 2:25PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Warren Buffett hasn't said anything about David Einhorn's controversial proposal to boost GM stock's value. But Buffett's previous writings make it clear that he will oppose Einhorn's efforts.

Star hedge-fund manager David Einhorn has a plan for how General Motors (GM -1.85%) stock can break out of its years-long slump. Greenlight Capital, Einhorn's hedge fund, has proposed that GM split its stock into two parts: one that continues to pay the current dividend but is entitled to nothing else, and one that is entitled to all future earnings growth.

Having failed to convince the GM board of directors that his plan has merit, Einhorn is taking his case to the rest of General Motors' shareholders. However, it's extremely unlikely that GM's most famous investor -- Warren Buffett of Berkshire Hathaway (BRK.A -1.32%) (BRK.B -1.63%) -- will respond favorably.

A Chevy Silverado pickup in a mountainous setting.

General Motors stock has been spinning its wheels recently. Image source: General Motors.

Buffett is likely to oppose Einhorn's plan for a simple reason: It does nothing to increase GM's intrinsic value. At best, it might persuade some investors to pay more for GM stock. For the same reason, I plan to vote against Einhorn's proposal with my General Motors shares.

What Einhorn wants

The rationale behind Einhorn's plan is that General Motors stock appears to be trading for significantly less than its intrinsic value. Einhorn explains that situation by saying some investors own the stock for its high dividend yield, currently just shy of 4.5%, while others hold it because they think it's undervalued and has good earnings growth potential. Neither group is willing to pay full value for GM stock today.

Splitting the stock into two parts may address this issue. Income investors could buy the shares that pay a high dividend, while value investors could buy the other "capital appreciation" shares.

The GM logo

GM opposes Einhorn's proposal. Image source: General Motors.

Einhorn believes that his plan would boost the combined value of these two hypothetical GM share classes to a range of $43-$60, from around $34 today. General Motors has countered that this plan "will not help GM sell more cars, drive higher profitability, or generate higher cash flow."

Buffett hasn't weighed in on the controversy yet, although Berkshire Hathaway is one of the biggest investors in General Motors stock. However, based on his previous writings, it's pretty clear that he will use Berkshire Hathaway's shares to oppose Einhorn's plan.

Rooting for underperformance

Buffett's 1997 Chairman's Letter at Berkshire Hathaway included a brief section on what he thinks about market fluctuations. He notes that if you plan to eat hamburgers or to buy a car, you would obviously wish for the price of beef and the price of cars to decline. Similarly, he argues that if you plan to buy stocks, you should wish for stock prices to decline.

Furthermore, Buffett notes that companies that repurchase lots of stock are essentially buying stock on behalf of their shareholders. In effect, investors in these companies are constantly buying more stock without lifting a finger.

As a result, Buffett concludes that only people who are eager to sell a stock soon should be hoping for its price to rise. It seems counterintuitive to many people, but patient, buy-and-hold investors are better off when their stocks stay undervalued.

This logic would certainly apply to General Motors shareholders, including Berkshire Hathaway. In response to Einhorn's radical proposal, GM noted that it plans to return $7 billion to shareholders this year, including about $5 billion of share buybacks. Based on GM's current stock price, that would be enough to reduce its share count by more than 9%. Individual investors can further increase their stakes by enrolling their shares in a dividend reinvestment plan.

Einhorn isn't a patient investor

From Buffett's perspective, the supposed benefit of Einhorn's plan -- that it would make GM stock rise -- isn't a benefit at all. In light of GM's aggressive capital-return plan, long-term investors should want General Motors stock to stay depressed for as long as possible, enabling the company to repurchase more of its stock.

This just goes to show that Einhorn isn't a patient, long-term investor. Generally speaking, patience isn't rewarded in the hedge-fund world. A couple of down years in a row can lead to huge redemptions from a hedge fund. That's why Einhorn is so desperate to get GM stock to break out of its current rut.

However, long-term investors should remember that General Motors stock has only been deeply undervalued for a couple of years at this point. The stock trades for a respectable 11 times its 2014 adjusted earnings per share of $3.05. What GM isn't getting credit for is its 100% surge in EPS over the following two years. (Adjusted EPS reached $6.12 last year.)

GM stock's underperformance indicates that many investors doubt it can maintain its earnings power. But if the company manages to continue growing its EPS in the coming years, investors will eventually overcome their skepticism.

From Buffett's perspective, patience and a healthy dose of share buybacks should be enough to make General Motors a very successful investment. Thus, Berkshire Hathaway will almost certainly oppose Einhorn's value-creation proposal for GM. 

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

General Motors Company Stock Quote
General Motors Company
$33.99 (-1.85%) $0.64
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$412,170.01 (-1.32%) $-5,529.99
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$273.86 (-1.63%) $-4.54

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 06/29/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.