Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) CEO Warren Buffett has built himself quite the fortune doing something that seems almost foreign to investors today. Namely, buying great companies with clear competitive advantages and holding onto them for very long periods of time. Time, as Buffett has learned, is the great differentiator of success when it comes to investing.
According to Berkshire Hathaway's annual report, released in February, its stock has delivered a compound annual gain of 20.3% over the past 55 years (ended 2019). That's more than double the compound annual return of 10% for the benchmark S&P 500, inclusive of dividends, over the same time frame. With Buffett sporting an extensive track record of beating the market, his advice, suggestions, and investments tend to receive a lot of attention.
All eyes were on Berkshire Hathaway's annual shareholder meeting this past weekend
Thus, you can imagine how intrigued Wall Street and investors were to get their hands on Berkshire Hathaway's first-quarter operating results, which were released this past Saturday, May 2, 2020, as well as listen to Buffett discuss the state of his company during a question and answer session as part of the company's annual shareholder meeting.
Keep in mind this wasn't your run-of-the-mill Berkshire Hathaway event. Because of the unprecedented disruption caused the coronavirus disease 2019 (COVID-19) pandemic, it's the first real chance investors have had to see what the most successful investor has been up to over the past couple of months.
Berkshire's Q1 operating results certainly told an interesting story, albeit not one that will likely encourage investors in the near term. Despite entering the year with a near-record $128 billion in cash, Berkshire ended March with an all-time high $137.2 billion in cash, cash equivalents, and short-term investments. Although Buffett and his team were net buyers of equities, according to the filed cash flow statements, the Oracle of Omaha acquired only $1.8 billion (net) of stocks during the quarter. That's not much considering the S&P 500 delivered its fastest decline into bear market territory in history and wound up losing 34% of its value in a mere 33 calendar days.
The one surprising stock that Buffett can't stop buying
Amid the abundance of caution that's been exhibited in 2020, as well as the lack of large purchases in 2019, there's one stock Warren Buffett simply can't stop buying of late: Berkshire Hathaway.
According to the newly filed Q1 report (page 42 of the report), Buffett and his team repurchased Berkshire's stock on three separate occasions:
- January 3 through January 15
- February 24 through February 28
- March 2 through March 10
All told, my calculations show that approximately $1.58 billion was used to repurchase Berkshire's Class A (BRK.A) and Class B (BRK.B) stock in the first quarter. This follows repurchase activity of around $5 billion in 2019 and more than $1 billion in common stock repurchases in 2018.
In order for Buffett and his right-hand man Charlie Munger to put the company's cash to work in the form of stock buybacks, two criteria have to be met:
- There needs to be at least $20 billion in cash and cash equivalents on the balance sheet.
- Warren Buffett and Charlie Munger have to agree that Berkshire Hathaway's stock is trading for a sizable discount below intrinsic value.
The first of these conditions is easily met, as the company has almost seven times the minimum required cash needed to execute buybacks. The second, however, is completely arbitrary. But it does suggest that, among a sea of arguably bloated valuations, Buffett and Munger view their own company as the most attractive.
Buffett and Munger have a point: Berkshire Hathaway stock is historically cheap
The question you're probably asking yourself is whether buying back Berkshire's common stock is really the best use of the company's cash hoard. To answer that, I'll lean on a comment from the Oracle of Omaha at the 2016 annual shareholders meeting:
Anytime you can buy stock for less than it's worth, it's advantageous to the continuing shareholders ... but it should be by a demonstrable margin.
This statement is noteworthy for two reasons. One, it introduces the idea that stock buybacks aren't get-rich-quick schemes. Although they reduce the number of shares outstanding, which can in turn lift earnings per share and make a company look more attractive from a valuation standpoint, a stock buyback is a long-term logistic maneuver that's undertaken when a company is selling for less than it's worth. In other words, it addresses short-sighted complaints concerning Buffett's use of cash.
Secondly, it really drives home how inexpensive Buffett and Munger view Berkshire Hathaway to be. If they're buying back their own stock rather than investing this capital into other companies, they believe Berkshire is the better bet "by a demonstrable margin."
From a fundamental perspective, getting aggressive on the buyback front would seem to make sense. Over the past decade, Berkshire Hathaway's share price has ranged between 18% and 59% above its book value (based on year-end totals). But at last check, Berkshire's common stock could be purchased for a mere 5% above book value.
If there's one nitpick, it's that the bulk of these buybacks occurred well before the selling really accelerated in the stock market. Buffett very clearly isn't a market timer. All $1.58 billion in purchases occurred at share prices that averaged 15% to 20% higher than where Berkshire trades today.
Certainly, we'd like to see Buffett put his capital to work in a variety of stocks. But the fact that he's been actively buying Berkshire stock since 2018 should inject a bit of confidence into the arms of Berkshire Hathaway shareholders.