Investing legend Warren Buffett announced Monday that Berkshire Hathaway (NYSE: BRK.A, BRK.B) might execute a share buyback for the first time ever – a bullish signal that it's time to buy stocks at record bargain prices.
Buffett said Berkshire is authorized to repurchase stock for the first time as long as its price is less than 1.1 times book value, and it retains cash holdings of no less than $20 billion.
Berkshire's Class A shares rose 8% Monday on the news, and Class B shares climbed 8.6%.
Buffett didn't just start a rally in his own company's stock, either. The whole market moved on news of Buffett's bullish sentiment.
The Dow Jones Industrial Average on Monday rallied 272 points, or 2.5%, and followed with another 148-point, or 1.34%, gain yesterday (Tuesday). That's after last week's drastic 738-point, or 6.4%, tumble in the Dow. The Standard & Poor's 500 Index is up 3.4% this week after last week's 6.5% fall.
"When Buffett does anything, it's not so much the economic impact but the psychological impact of what he does, and this was hugely important from a psychological perspective," Larry Glazer, managing partner at Mayflower Advisors LLC, told The Wall Street Journal.
Now investors are looking for their own Buffett-style bargains, believing that the famed investor's moves mean it's time to buy.
Why Berkshire Would Make a Rare Share Buyback Move
Buffett has long been against share buybacks.
"The continuing shareholder is penalized by repurchases above intrinsic value," he wrote in Berkshire's 1999 annual report. "Buying dollar bills for $1.10 is not good business for those who stick around."
He said buybacks were usually only motivated by an "ignoble reason: to pump or support the stock price."
So what would change his mind now?
Buffett's move signals his belief that big-name stocks are going for bargain prices – and they are "Buys" because the U.S. economy will avoid another recession.
"If he thought the possibilities of a recession were on the horizon, then he'd wait to do this," James Dunigan, chief investment officer for PNC Wealth Management, told Bloomberg of Buffett. "You can make a number of arguments that on some traditional measures, the market is undervalued."
Indeed, this is a sign Buffett thinks his Berkshire shares are extremely cheap. Analysts estimate Berkshire stock's intrinsic value is $130,000 to $150,000 per share, 20% to 39% higher than Tuesday's closing price of $108,020.00.
Since Berkshire's share price tends to rise and fall with the overall market, faith in his own stock has spread to other companies.
"He has a lot of investments in the largest companies in the market, so putting his money in Berkshire is another way of being bullish on the market," Eric Green, a fund manager at Penn Capital Management, told Bloomberg. "If the stock market is going down, then his stock will go down, and he's certainly smart enough to know that and he thinks the market is undervalued."
Berkshire is estimated to have $77 billion in cash and cash equivalents, and per stipulations in the buyback plan it has to keep holdings at $20 billion – leaving $57 billion to spend on its own stock.
Berkshire is one of many U.S. companies to buy back shares with their record-high cash piles. U.S. corporations in the second quarter bought back $475.2 billion more of their own shares than they issued, according to the U.S. Federal Reserve.
In August, 198 companies authorized new share buyback plans, the most since February 2008. This year is set to be the third most active buyback year on record – and a sign that U.S. companies aren't concerned about another recession.
"If Buffett thought there was even a meaningful chance of that happening, he would not buy back any stock; he would hang on to the cash and wait to put it to work," Whitney Tilson, from hedge fund T2 Partners, told The Financial Times. "In 2008 he put $50 billion to work; he would love to have that opportunity again."
Buffett attempted a share buyback during the dot-com era when Berkshire's share price fell below $45,000, but told CNBC's "Squawk Box" program that the reaction to his announcement was "self-defeating" because the stock went up before he bought any.
Berkshire's plan stipulates the company pay no more than 10% premium to current book value. Berkshire set its book value at the end of June at $98,716 per Class A share and $68.71 per B share.
Berkshire A and B shares closed 9.4% and 4.7% higher than their respective book values.
News and Related Story Links:
- Money Morning:
Warren Buffett is Taking Berkshire Hathaway Inc. (NYSE: BRK.A , BRK.B ) on the Hunt for Takeover Targets
Buffett Buyback Shows S&P 500 May Be Bargain
- The Wall Street Journal:
Buffett Spots Fresh Bargain: Shares in His Own Company
- The Financial Times:
Buffett launches first Berkshire buy-back