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Jul 18, 2018

Berkshire rallies on Warren Buffett's 'game changer' for share buybacks

Berkshire loosens buyback policy

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Berkshire Hathaway Inc. shares climbed the most in four months after the company signaled that investors may soon get their hands on part of a US$109 billion mountain of cash that’s bedeviling Warren Buffett.

The firm’s board announced late Tuesday that it’s removing a cap on stock buybacks, giving the Berkshire chairman and chief executive officer greater leeway to parcel out profits, rather than hunt for more acquisitions. Buffett and Vice Chairman Charlie Munger can now make repurchases whenever they both believe the price “is below Berkshire’s intrinsic value, conservatively determined,” the company said.

Berkshire’s Class A shares advanced 3.9 per cent to US$299,770 at 9:59 a.m. in New York, the most intraday since March 9.

Berkshire for decades has favored Buffett’s strategy of acquiring well-managed companies and stitching them into an ever-growing conglomerate. But in recent years, the massive company has turned out profit faster than it could redeploy the money. The war chest swelled past US$100 billion last year, prompting some die-hard investors to wonder whether Buffett should just pay some out. Now he can.

“It’s a game changer,” said David Rolfe, the chief investment officer at Wedgewood Partners, an investment manager that oversees US$4 billion, including Berkshire shares. Buffett could afford to spend in the “low tens of billions” of dollars on buybacks every year, Rolfe estimated.

The firm’s earlier repurchase program stipulated the price paid couldn’t be more than 20 per cent above the current book value of shares. Book value is a measure of assets minus liabilities, which Buffett has called a useful -- though understated -- proxy of his conglomerate’s “intrinsic value,” or what it’s really worth. Berkshire’s Class A shares closed Tuesday at US$288,500, or 37 per cent higher than the company’s book value at the end of the first quarter.

Buffett, 87, began a buyback program in 2011 after shunning repurchases for four decades. But opportunities to acquire shares remained scarce as the company initially prohibited purchases at stock prices above 110 per cent of book value. It raised the limit to 120 per cent in December 2012. Since then, some investors have viewed the threshold as a floor under the stock -- keeping the price out of reach for buybacks.

Buffett had been toying with the idea of loosening the rules further, saying in a February interview with CNBC that the company might have to tweak the equation. He’s emphasized that he generally prefers to repurchase stock than issue a dividend.

Even under the changes announced Tuesday, Berkshire said it won’t repurchase stock if doing so would reduce the value of its cash-like holdings below US$20 billion. That’s not likely to constrain Berkshire given the huge sums of cash the company holds, according to Morgan Stanley analysts led by Kai Pan. One of the company’s main businesses is insurance, which can incur large claims costs.

“We’re never going to do anything that we think is harmful to continuing shareholders,” Buffett said in May at Omaha, Nebraska-based Berkshire’s annual shareholder meeting. “So, we think the stock is intrinsically worth X, and we would have to pay some multiple -- some modest multiple, even above that -- to repurchase shares.”

‘Overdue’ Decision

Aside from acquisitions, Berkshire also invests in shares of other companies. Its portfolio includes tens of billions of dollars in Apple Inc., Wells Fargo & Co. and Coca-Cola Co. But a long bull market has made it harder to find bargains.

Lifting the cap is “overdue,” Meyer Shields, an analyst at Keefe Bruyette & Woods Inc., said in an interview. Berkshire’s book value hasn’t been as useful a measure of the company’s intrinsic value as Buffett has pursued more deals for operating companies, he said.

“This is something that’s been talked about for years,” Shields said. “This ever-growing cash pile is now overwhelming.”