The Highlight of Warren Buffett's Annual Shareholder Letter Was About Stock Buybacks

In this podcast, Motley Fool senior analyst Jason Moser discusses:

• Warren Buffett's vigorous defense of share buyback programs.
• How Berkshire Hathaway's investment portfolio reflects Buffett's beliefs on share buybacks.
• McDonald's expanding its test of Krispy Kreme doughnuts to 160 locations, and what it could mean for investors.

Motley Fool contributors Toby Bordelon and Jose Najarro engage in a bull vs. bear debate over one of the most popular gaming apps: Roblox.

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This video was recorded on Feb. 27, 2023.

Chris Hill: Warren Buffett brings the spice while McDonald's is cooking up something sweet. Motley Fool Money starts now. I'm Chris Hill. Joining me today, Motley Fool senior analyst Jason Moser. Thanks for being here.

Jason Moser: Hey, thanks for having me.

Chris Hill: We are still in earnings season. One additional way that Berkshire Hathaway avoids the spotlight is they put their release out after the market closes on Fridays. That happened this past Friday. The fourth-quarter results for Berkshire Hathaway took a back seat to Warren Buffett's annual letter. The highlight of which was Buffett defending the practice of share buybacks and the money quote that's making the rounds, Jason, is Buffett writing, "When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you were listening to either an economic illiterate or a silver tongued demagogue." Then he adds in parentheses "characters that are not mutually exclusive." This is a side of Buffett we haven't seen in a while. He is frequently defending his investing approach and the American economic system. It's not often that he's taken shots at people and I like it.

Jason Moser: Well, I agree with you. I always like these letters. They always carry a certain level of familiarity, yet always also contain passages that make you think and see things perhaps from a different perspective. I think in this case it is worth noting, I want to be fair here because I know a lot of people jump on this immediately make it political because we've seen obviously DC lobbing up the one percent tax on share repurchases. Of course, this is something that becomes a political football. But it is worth noting, at least in that quote. Like he does emphasize a few words in there and the emphasis on the word all, I think it's important to say he's clear to stress that word all. He's not saying that repurchases are always good. That's his point. There are good and there are bad repurchases. I appreciate that because he's right.

Share repurchases often can be very effective. They can also be horribly executed, and so that's something always to keep in mind. I do like how he pulled the example out from the letter of like this ultimate two-sided network. We talk about two-sided network businesses like something like a block, like a square, where they benefit from two sides of the network. The buyers and the sellers. I like Berkshire share repurchase two-sided network. They repurchase some of their own shares throughout the year. But then they also benefit from the companies that they own making those repurchases as well. He calls that Apple and American Express is two examples in there. But just that the company itself is benefiting from repurchasing its own shares because they deem it to be a worthwhile value.

But there are also benefiting from companies like Apple and American Express repurchasing their shares, which then in turn gives them greater ownership in what they own in their own portfolios. I do like that he made this a theme. It seems appropriate because, we also saw, I guess it was at the state of the union this call to ramp up the tax on buybacks as if one percent is not enough. Not terribly surprised that we haven't seen companies really push back on one percent because at the end of the day, I believe that's one percent just on the net as well. It's not like just gross buybacks.

But you start pushing for more and more and you're going to start seeing some push-back, and so I think our politicians would certainly be wise to keep that in mind. Because really the passage that stood out for me in the letter and it's not one that really pertains necessarily to Buffett or Berkshire or Munger, but they call out that during the decade ending in 2021, the United States Treasury received about $32.3 trillion in taxes while it spent $43.9 trillion. Now Chris, I didn't major in mathematics in college. I did major in economics. I did some work with math. I had to take calculus and stuff like that. Ever since I was a kid, my parents have said, listen, just don't spend more than you make. Don't live beyond your means.

Well, what we're seeing here is a shining example of living well beyond our means as a country. I'm glad that they call that out because there are two sides at play here. Sure, taxes are fine. But you also want to keep the spending in line with the taxes. What we've seen by his example here is that those are not in line and that can be a problem. For him to use that share repurchase example in the letter I think was good. I'm glad that he emphasized all because if you know then you know. He's not saying that all share repurchases are bad or good. There are varying degrees. Make sure that the businesses that you own are executing reasonable, rational buybacks. If they are, then you as a shareholder should feel the benefits of that over time.

Chris Hill: Buffett's letter is available online. You don't have to be a shareholder to access it. You don't have to be a shareholder to get lessons from it. Thank you for highlighting the specific example within the letter as it relates to buybacks, because it's not really a surprise that two of the biggest positions in the Berkshire Hathaway investment portfolio, Apple and American Express, are businesses that on average do a better job than others when it comes to share buybacks.

Jason Moser: Yes, they do. Furthermore, he calls that the example of the dividends as well over time with businesses like Coca-Cola and American Express and talking about when they first establish those positions. The amount of money they were pulling in on those dividends versus those positions and the dividends that they're bringing in now, which is really impressive to think about. You're talking about what? 1994, they opened up the Coca-Cola position. I think he brought in something around $70 million in dividends from that position. Then you fast forward to today. Today that increased to $704 million. But that's in a passage of the letter called the secret sauce. I thought that was a good one to include because it really does focus in on just the time, the patience, ultimately the lesson for investors that he quotes, and this is a good quote.

It really lines up with something we say here a lot. We like to say pull the weeds, water the flowers. Over time, you don't need, but really a handful of really good winners to make all the difference in the world. He concludes this segment of the letter, The Lesson For Investors, the weeds wither away insignificance as the flowers bloom over time. It takes just a few winners to work wonders. There's a lot to be said for that. It's just a lot easier to see in hindsight, and the problem is that when you're seeing it in hindsight, if you didn't do it, well, you don't really have the time to do it then going forward. Which is why it's so important to get started early and stick with it.

Chris Hill: The letter and the point he makes about buybacks is timely because you had shared this with me earlier today. A Wall Street Journal article about share buyback plans being on the rise. It's not just Berkshire Hathaway and Apple and Amex. I didn't want to get your reaction to one quote in that article though. The point was made. Well, with share buybacks, shareholders benefit without taxes being involved. It theoretically, with the share count coming down. It's not until you sell, presumably at a capital gain that you're dealing with taxes, whereas with dividends, that is a taxable event and I forget who it was, but I think money manager type is quoted as saying this and I'm paraphrasing here just like, give me share buybacks all day long. I love this.

I wanted to get your reaction to that because to the point you made earlier, it seems like as a group, companies do a better job paying out dividends than they do with share buyback plans. There are a lot of companies that do not time the buyback plan correctly, whereas if you're just going to give me that quarterly dividend, that annual dividend, I decide what I can do with the cash. Yes, it is a taxable event but I don't know. Maybe it's just me, but I like them both. I prefer the dividends more.

Jason Moser: Well, you're right there in regard to the buybacks. I think that the data that we saw buybacks by companies in the S&P 500 this year are projected to hit one trillion dollars. I think that's for the first time ever in a calendar year based on the data that we have today. It certainly seems like the authorizations are out there for a lot of these companies to repurchase shares. That makes sense. We've seen the market obviously undergoing a lot of stress lately. You see a lot of companies out there that probably feel like their share price represents a greater value today. For sure you want to see management teams taking advantage of that. But I tend to agree, I like them both just like you. But one is more theoretical and the other one is far more just based on pure math. A dividend is cash in your pocket.

It is a taxable event, but also you have to remember, it may not necessarily be a taxable event depending on where you hold that dividend stock. It always is worth keeping that in mind. But dividend, that's one of the reasons why people love them, it's cash in the pocket. It's based on the performance of the business. If you've got a pretty steady eddie reliable business, something like a Coca-Cola for example. No, it may not light the world on fire. It's probably not going to grow a heck of a lot from here other than just to keep pace with inflation. It's a very reliable business that produces a ton of cash and management wants to promote that by offering their shareholders dividends. The longer you hold on those dividends, you have to remember too, the more you get paid those dividends, the lower your cost basis for that share becomes. But generally speaking, dividend being cash in the pocket, I love that. I think the older you get, the more you start to realize the benefits of that.

Jason Moser: Well-timed share repurchases can obviously be tremendously beneficial, but it also requires the market to recognize that and it requires also the market to be in a certain mindset at a given time. It's a bit more theoretical. From that perspective, they can be a little bit more tricky to quantify the value that shareholders may receive, certainly in the near term, but that really just goes to the nature of the two.

Chris Hill: One more thing I wanted to get your reaction to, and this is a completely different topic. McDonald's has been quietly testing the sale of Krispy Kreme Doughnuts, at a couple of locations that test is about to get bigger. Starting on March 21, McDonald's is going to be selling Krispy Kreme Doughnuts at 160 locations in Kentucky, mainly in the Greater Louisville and Lexington areas. Shares of Krispy Kreme popped when this news broke, it settled back down. But if this goes national, doesn't that materially improve Krispy Kreme's business or does McDonald's just hold way too much power in that relationship?

Jason Moser: It definitely improves their business to the extent that it gives them a much larger store footprint than they have currently, and they don't have to really build that footprint out, so to speak. McDonald's is obviously a much larger business than Krispy Kreme today. But it does feel like it's a mutually beneficial relationship. It gives Krispy Kreme a way to quasi-franchise their doughnuts by getting them in more stores like a channel development agreement that you would see with a grocery store or something like that. But it absolutely benefits McDonald's too even if it's just on the margin. You think about what is one of the most crucial metrics for a restaurant? It's traffic. You've got this fixed cost base in the restaurant building and the staff and operating it day-by-day. The more traffic you can push through that restaurant, the more you can sell.

Not only are you generating higher revenue, but because of that fixed cost structure, you start to become more profitable the more and more people you can push through that restaurant. This is one of those things where it can give McDonald's certainly the opportunity to gin up a little bit more traffic. Even if they don't make any money at all on the doughnut sales, it certainly could gin up incremental sales, whether it's coffee or whatever else it may be. It makes a lot of sense, certainly from Krispy Kreme's perspective, in that it gives them an opportunity to grow a lot more quickly than they would have been able to do otherwise without necessarily having to invest the same amount of money. But it absolutely can help McDonald's from the traffic side, which ultimately can incrementally lose those margins over time.

Chris Hill: Jason Moser, always great talking to you. Thanks for being here.

Jason Moser: Yes, sir. Thank you.

Chris Hill: Before this next segment, I have to tell you a bonus episode of the Stock Advisor Roundtable just dropped today. It's Motley Fool co-founder and CEO Tom Gardner, talking about 10 stocks that he believes will help investors make money in the market. If you're already a listener to the Stock Advisor Roundtable podcast on Spotify check it out when you're done with this episode. If you're not yet a listener, check the links in the show notes of today's episode for how you can link your Motley Fool account with Spotify. Roblox has more than 65 million daily active users and somehow is still losing more than $900 million a year. Can growth meet profitability? Ricky Mulvey hosts a bull versus bear debate on one of the most popular gaming apps.

Ricky Mulvey: This bull versus bear debate comes to us from Robert, who wrote to us. My son Noah wanted to know if you could do a bull versus bear on Roblox. He owns a few shares of the company and is trying to decide if he wants to buy more. We can absolutely do that. We got one on the online game platform and game creation system. On the bull side, we have Jose Najarro. Jose, good to see you as always.

Jose Najarro: Hey Ricky, and thank you for having me and I'm super excited to get started with today's episode.

Ricky Mulvey: Likewise, but before we do, we got to introduce the bear Toby Bordelon. Good to see you and thanks for joining us to give the bear case.

Toby Bordelon: Thanks for having me on Ricky looking forward to this.

Ricky Mulvey: Without further ado, let's get going. On the bull side Jose Najarro, five minutes is yours.

Jose Najarro: Thank you, Ricky. There are many reasons to be bullish on this gaming giant but let's start with the most important gamer growth. In January of 2023, the average daily users reached 65 million for Roblox up 19 percent year over year and hours engaged were 5 billion hours also up 19 percent year over year. While many thought COVID was going to be the peak for gaming, and it was unfortunately for some games, but it wasn't for Roblox. Another untrue fact that is going around for this gaming giant is that the growth of users is only coming from international regions, but that is not the case. In quarter 4 of 2022, Roblox did grow internationally. Europe was up 24 percent, APAC was up 21 percent, but the company reported growth in United States and Canada, an increase of 19 percent year over year. Ours also grew 29 percent in the same region. Growth is still very healthy in the Americas.

Unfortunately, another fear that comes when we think about Roblox, is that some might say this is a game only meant for young people. But in quarter 4 Roblox reported that 17-year-olds to 24-year-olds accounted for 22 percent of all daily active users in the quarter, up 31 percent. They also accounted for 23 percent of all hours played in that quarter, up another 33 percent. Bookings for this age group was up 34 percent, accounting for 22 percent of total bookings in the quarter. Roblox gamers are still growing both domestically and in other parts of the world. The older gamers, like I mentioned, that 17-24 account for at least 20 percent of bookings, hours engaged, and daily active users and they're one of the fastest-growing demographics for this platform.

Outside of user growth, there are another few reasons to be bullish in this company and that has to do with the strong financials. While like many growth stocks, it is plagued by high stock-based compensation and negative free cash flow due to heavy investments. Negative 37 million in free cash flow in this most recent quarter, cash flow from operations has been positive for at least the past 13 quarters. Cash and cash equivalents are roughly three billion dollars and only one billion collars in long-term debt. Let me break down that company's liability a little bit more.

The company has a total of five billion dollars. In total liabilities, one billion dollars I mentioned already come from that long-term debt. But listen to this, roughly three billion dollars comes from deferred revenue. In theory, this company really only has two billion dollars in liability if you include that long-term debt. The company can pay everything off and still have one billion dollars in cash and cash equivalents and that is not even including accounts receivable, which in quarter 4 was roughly $300 million. A quick look at valuation also shows a price-to-sales ratio of roughly 10. While it might not be the cheapest, it is a software-style game that tend to have higher margins. The final growth opportunity I want to discuss is the future of the game.

The company has plenty of digital real estate to continue to push this advertisement move. Unfortunately, right now the advertisement wallet is shrinking, but I do believe this is something that will grow over time. Next, we see numerous artists and companies continue to build experiences on Roblox, from education to music, to other fashion shows also happening on the platform. I can't end this without talking about artificial intelligence. Generative AI can help this company grow via coating new experience, creating animations, and even improving the non-player characters' conversation.

Jose Najarro: I actually want to mention one more thing, augmented reality and virtual reality continue to grow in the consumer space, it's still very early, but Roblox continues to provide tools to bring this to the platform. While this is not a risk-free investment, and as we will hear, there are various bearish case for this company, the company does have numerous growth opportunities. Ricky, I do believe those are some great reasons to be bullish on this gaming giant.

Ricky Mulvey: Jose, thank you for the bull side. When we flipped the coin, Toby Bordelon, you got the bear case. Five minutes is yours.

Toby Bordelon: Thanks, Ricky. Jose does make some interesting cases here for being bullish in this company. But the thing about numbers, is you can look at them in several different ways. I want to take a look at these metrics that Roblox gave us, and look at the trends we've been seeing over time. I don't think it paints quite a rosy picture as we might like to think. When Roblox announced earnings last week, the stock jumped up almost 25 percent at one point. It has since come back down, which I'm sure it's a disappointment to many shareholders, but I don't think that initial optimism made a lot of sense when you really look at it. It's not consistent with the trends we've been seeing. Let's take a look at some of those metrics right now. First point about those metrics, the company did tell us in their earnings report.

They're actually not going to be providing monthly metrics data anymore. The last monthly update is going to be with the March numbers in a couple of months here. They say this is because they are focused on the long term and the monthly reports are going to lead to short-term market reactions. I get that, sure. But I never like seeing a company move in the direction of less transparency and less accountability. I think that's what they're doing here. That gives me a little pause about the communication where we're seeing from management going forward. Now onto those metrics. One knock on Roblox, that the company does cater to a very young audience, as Jose mentioned. Yes, that audience is getting older, but the younger group still is the core of their audience. This has raised some concerns, overuses safety.

The company is addressing those concerns, but it's actually expensive to do that spending on trust and safety and infrastructure rose 39 percent last quarter, $129 million. Given the serious damage that a safety incident would cost the company, I think we can safely assume that spending is going to continue to rise, so they've got those costs to worry about. Now, users are continuing to grow, it's true, but that growth is slowing. As Jose mentioned, daily active users grew 19 percent in the fourth quarter of 2022. That sounds good in isolation, but when you look at the company's history, it's not so great. That's actually the lowest growth rate in daily active users for any quarter going back all the way to the fourth quarter of 2019. Even worse, on a sequential basis, daily active users were flat in the prior quarter.

We're not seeing quarter-over-quarter growth as we have in the past. Hours engaged, grew 18 percent sure, but that's also at the low end of what we've seen before. Sequentially hours engaged actually fell from the third quarter. Not a great sign. Revenue did grow year-over-year in the fourth quarter, it's true by two percent. That actually matches the lowest quarterly year-over-year revenue growth Roblox's reported since that fourth quarter of 2019. What was the other quarter with that low two percent growth you might ask? That would be the immediately prior quarter, Quarter 3, 2022. That's right. For the past two quarters, we've seen revenue growth only at two percent. That is a far cry from the triple-digit growth rates we were seeing in 2021. That should be a serious concern to shareholders I think. Another thing to consider, that two percent Q4 growth is substantially less than inflation over that same period.

In other words, you can look at that and say, hey, Roblox's revenue growth is actually negative in real spending terms. That's not great. Bookings did rise nicely last quarter, that's good. But again, that 70 percent increase in bookings we saw is below anything we saw in 2021 or 2020 or 2019. It's kind of good news, but we're still pretty far from that high growth in the past. And there's no reason to believe, I think, that bookings are going to return to those prior levels anytime soon. The news gets worse if you look at the average bookings per daily active user. That number was down two percent for the quarter. This is actually the sixth consecutive quarter with a year-over-year decline in average bookings per daily active user. That's tells us that while the company might be growing its user base, the marginal user is less and less valuable.

You got to ask yourself, what happens when that user group starts to level off? Like it looks like it's doing right now. Do revenue and bookings start to decline? They could, and that's a real concern. The company's costs are also skyrocketing. Revenue growth is slowing, costs are skyrocketing. Total costs and expenses grew by 24 percent in Q4. That's 12 times that revenue growth rate we saw. That's not the way to move your company toward profitability. Let's think about that profitability for a moment, or I should say, the lack of profitability. The company's offering loss in Q4 was 300 million. For the full year at 924 million, operating loss. On a net income basis, Roblox lost 290 million for the quarter and 934 million for the year. Now, you might say, hey, that's just an accounting loss and they're cash-flow positive.

That's what Jose was telling us, they're operating cash flow positive. Maybe, but not really. When you dig into that cash flow statement, you're going to see some concerns. It does show a positive operating cash flow of 119 million for the quarter, about 370 million for the year, but to get there, they have to back out stock-based comp. Stock-based comp was 196 million for the quarter and 589 million for the year. That wipes out that operating cash flow entirely. In other words, the cash this company is generating from its operations, that's going to employees. The shareholders aren't seeing any of that actually favoring that stock-based comp dilution.

Even with that stock-based comp add back, they're still not producing enough operating cash flow to cover their capital spending. The company is free cash flow negative right now. That's bad news for shareholders, but even worse, it's the fact that that's negative free cash flow we're seeing is a recent development. Up until the second quarter of last year, 2022, the company was actually free cash-flow positive. Now, normally, you accept a cash burn from a young company that's growing. You're expecting that to turn positive over time. But when you see a young growing company that has historically been free cash-flow positive and that turns negative, I think that's a warning sign that investors should pay attention to. They are spending a ton of money on compensation cost. Labor costs rose 32 percent last quarter, and that's before you even factor in the stock-based comp.

Those numbers are without stock-based comp. When you factor in that stock-based comp that we've talked about, it gets even worse. Bottom line here, the trends aren't great for this company. We've got slowing growth all around, slowing user growth, slowing revenue growth, slowing bookings growth, and any way you look at it, growth is much slower now than it was a couple of years ago. That by itself is not a concern, but there are a lot of other companies out there, solid companies that are slowly growing and delivering good shareholder value. I don't see that from Roblox. The ones I'm aware of are all profitable, not like Roblox. I look at this company, I see a company that's not profitable, where growth is slowing, and I think there are better investments out there.

Ricky Mulvey: Toby Bordelon, thank you for the bear case. Jose Najarro. Thank you for the bull case, strong cases on both sides so make sure you pick who made the better argument, we'll have a poll up at Motley Fool Money on Twitter because what is today's lucky winner going to receive? Well, today's lucky winner is going to receive a subscription to a Roblox gaming YouTube channel, relive the joy of going to a friend's house and watching them play their favorite video games all day long. Join millions of other viewers who are watching other people play games such as Pet Simulator X, Beep City and Hide and Seek Extreme. That's not all, we'll also throw in two tablets of Dramamine, to fight any motion sickness you might experience while watching this channel. This fabulous prize package could be yours if you win bull versus bear.

Chris Hill: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.