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Warren buffett thinks his own company is a bargain

One of the world’s best investors thinks the stock he knows best is undervalued.

Warren Buffett is an investing legend, known for his stock-picking prowess and an unmatched record. Over the past 50 years, NYSE-listed Berkshire Hathaway – Buffett’s main investing vehicle – has compounded its book value at 19% a year on average. A mere $20 invested in the stock when Buffett became chief executive would be worth almost $300,000 today.

And that’s why Berkshire’s decision to repurchase more than US$1.0bn of its own stock over the past five months is so important. Here we have the world’s most acclaimed investor signaling that the stock he knows best is undervalued.

Berkshire has an uncommon capital allocation policy among large businesses. No dividend has ever been paid and the company has only repurchased its own shares a couple of times in its history – in 2011-12, and the repurchases since August. Money isn’t returned to shareholders; instead, it’s put to work buying undervalued businesses. Shareholders have been better off for that policy, as a dollar in Berkshire generally compounded faster than had it been distributed to shareholders for reinvestment elsewhere.

Buffett’s decision to favour the purchase of other businesses over Berkshire’s own stock hasn’t been a matter of quality or competitive advantages, both of which Berkshire’s roughly 100 subsidiaries possess in droves. What kept Buffett away was a matter of price.

Selective purchases

In 2011, Berkshire introduced a formal repurchase policy that restricted repurchases to when the stock was trading at no more than 10% above book value. In 2012, this threshold was raised to 20% above book value, but Berkshire only repurchased around US$1.3bn in stock during this period, mostly from one long-term shareholder. The share price never reached a big enough discount to qualify for repurchases – Buffett's army of disciples saw to that.

In July, Buffett again updated Berkshire’s repurchase policy. This time, though, there is no price-to-book limit; repurchases can be made at any time that both Buffett and Charlie Munger, a Berkshire Vice Chairman, ‘believe that the repurchase price is below Berkshire’s intrinsic value, conservatively determined’.

Berkshire’s share price immediately jumped 5% on the news, but this didn’t deter Buffett. According to Berkshire’s quarterly report, the company repurchased US$928m worth of its Class A and Class B shares between August 7 and 24. The average purchase price was US$312,807 for the Class A and US$207 for the Class B.

'We need a big enough discount so we're buying at what we know is a price where the continuing shareholders are going to be better off because we bought it', Buffett said in a recent interview with CNBC. 'We're running a business for the people who are going to stay, not the ones who are going to leave.'

Repurchases stopped on August 24 when the share price was US$210, or roughly 1.43 times book value. This might be the upper level for repurchases Buffett has in mind. We can also tell that additional purchases were made between October 1 and October 25 due to a share count disclosure attached to the company’s quarterly report, but the exact details won’t be known until the next quarterly report. The share price traded between US$201 and US$223 during that time. With a current share price of around US$197, Berkshire is trading at 1.30 times its US$152 per share in book value.

Buffett grew Berkshire using a few core principles: buy high-quality businesses with competitive advantages and good management, and only when the share price offers a wide margin of safety. Buffett spends his days scouring the market for good deals. Today, the message is clear: one of the cheapest companies out there is his own stock.

Disclosure: The author owns shares in Berkshire Hathaway.

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