Berkshire Hathaway (BRK.A -0.70%) (BRK.B -0.76%), the conglomerate led by billionaire investor Warren Buffett, typically does not use the traditional methods of returning capital to shareholders: dividends and share buybacks.
Although Buffett mentioned the possibility of a dividend at Berkshire's shareholder meeting, the company has not declared a cash dividend since 1967, and it's fair to say that management isn't too keen on the idea. On the other hand, buybacks have been a part of Berkshire's strategy in the past, and they could certainly happen again, given the right circumstances. In a nutshell, management looks at buybacks as an opportunity to potentially buy back the company's assets for less than their intrinsic value.
With that in mind, here are two reasons Berkshire could decide to start buying back shares in the near future.
Warren Buffett has a cash problem, and buybacks could be a solution. Image source: The Motley Fool.
Berkshire has way too much cash
As of September 30, 2017, the end of the third quarter, Berkshire Hathaway had more than $109 billion in cash on its balance sheet. Warren Buffett has said that the he prefers to keep about $20 billion in reserves at all times, so this means Berkshire has nearly $90 billion in cash sitting around.
The problem is that this cash isn't making much money for Berkshire and its investors, nor is it helping the company grow its future earnings power.
Why does Berkshire have so much cash right now? Simply put, valuations of stocks and potential acquisitions are quite high right now, and Berkshire would need a massive acquisition, or series of several smaller purchases, in order to make a meaningful dent in its cash. This combination has made finding attractive investment opportunities rather difficult.
To put Berkshire's cash problem into perspective, consider that the company's largest purchase of all time was Precision Castparts for $32 billion. The company could buy another company of this size and still have about $57 billion left that to spend.
Berkshire's book value keeps rising
Over the past year, Berkshire Hathaway's book value has grown by 8.9% to $187,435 per class A share, which translates to about $125 per class B share.
Here's why this is important. Berkshire bases its willingness to buy back shares on their price-to-book multiple. Specifically, Berkshire's board has currently set its buyback authorization threshold to 120% of book value. Based on the current share price, this means the company would start buying back shares if they were to fall to $150.
Obviously, this isn't close to Berkshire's current valuation. As I write this, Berkshire trades for about 146% of book. However, management could be willing to bend on its buyback threshold, especially if the cash stockpile continues to grow. And as book value climbs, the distance between the current valuation and where the company would be willing to buy back stock will continue to narrow.
Will it happen?
At this point, there's no way to know for sure what Berkshire will choose to do with its massive cash hoard, but it's getting so big that it's become a serious problem for the company. No part of Berkshire's value-creation strategy involves keeping massive amounts of cash on the sidelines at virtually zero growth.
With that in mind, while I don't foresee the company using a huge portion of its cash on buybacks, I wouldn't be at all surprised if the company removes its usual buyback valuation threshold and decides to start a share repurchase program -- at least until the cash problem is brought under control.
