Technically, Warren Buffett didn’t spend $12 billion on one stock. Instead, his company, Berkshire Hathaway (BRK.B), decided to buy back $12 billion in its own shares. The move surprises some people, but it makes sense within a broader context.
Berkshire Hathaway’s Approach to Stock Buy Backs
While most of corporate America has been on a stock buy back spree for decades, Berkshire Hathaway has shied away from the trend when it came to their own firm.
Buffett, Munger, and other decision-makers within the company were more focused on acquiring other businesses and purchasing stocks that had opportunities for long-term growth.
In recent years, however, Berkshire share price failed to match the S&P 500. This underperformance was rare and not representative of the past 50 or so years, where Berkshire on average performed twice as well annually as the broad index of America’s top 500 companies.
Berkshire Hathaway started to buy back more of its shares, a clear sign that Buffett and Munger believe the firm was significantly undervalued. During the first two quarters of 2021, the investment firm spent more on stock buy backs than acquisitions and investments combined.
Buffett Believes Berkshire Hathaway Is Undervalued
Berkshire Hathaway certainly isn’t basing buy backs on stock price. It bought a lot of its shares in June, when the price hovered around “$435,000.”
Historically, Buffett looked at book value as a way of identifying the relative undervaluation or overvaluation of Berkshire shares. But in recent years he has migrated away from that rule of thumb metric to analyze share price based on other fundamental factors.
Even a rudimentary calculation of Berkshire cash flows suggests the firm is still undervalued, even after Buffett committed to $12 billion to snapping up shares. At current levels, another 10% or so of upside potential remains in both Berkshire A and B shares.
Buffett’s decision to start buying Berkshire Hathaway says something very important about how he sees the current market.
Out of thousands of companies, he selected Berkshire Hathaway. He’s a pragmatic person, so he didn’t make the decision for vain reasons. He must truly see Berkshire Hathaway as the best investment opportunity in the current market.
Berkshire Buy Back Makes Sense Within Context
If you’re a bit dumbfounded by Buffett’s decision to spend $12 billion on a single stock? Look at it within the context of Berkshire Hathaway’s typical approach to investing.
Buffett and Munger are famous for not making rash decisions. They show little interest in buying the hottest stock for short-term gains, though companies like Snowflake have crept into their portfolio. They prefer long-term performance and steady growth.
When you look at the stock market right now, Berkshire Hathaway fits that description very well. Other than a few dips that correlate with wider drops in the market, Berkshire Hathaway’s value has been growing consistently since its founding.
The most recent dip happened in March 2020, when the world realized that it was entering a phase of enormous uncertainty as coronavirus spread rapidly around the planet. Other than that, Berkshire Hathaway’s value has been climbing since the economic recovery following the Great Depression.
Similarly, consider that Berkshire Hathaway earns most of its money by investing in and acquiring companies. In some ways, you could interpret it as an independent index fund run by one of the world’s greatest investors. Buying back shares ensures that more of its profits go into the pockets of current owners instead of letting more people buy-in.
It also shows that Buffett and Munger believe they have made evidence-based decisions creating their portfolio. The Berkshire Hathaway buyback demonstrates exceptional faith in the companies they invest in.
That likely says good things about the futures of companies like Apple, Bank of America, American Express, and Coca-Cola. If Berkshire Hathaway owns more than 900 million shares in Apple, a buy back displays faith in Apple’s growth.
How High Could Berkshire Hathaway Climb?
The fact of the matter is that Buffett and Munger believe Berkshire Hathaway is currently undervalued by the market. They saw this as an opportunity to purchase shares in a company with more long-term growth.
Forget that Buffett and Munger control Berkshire Hathaway. Instead, consider that they made an evidence-based choice, and they decided that Berkshire Hathaway was one of the best companies to buy in 2021.
This brings up a critical question: How high could Berkshire Hathaway go?
If we look just at the A-shares of Berkshire, the answer is approximately $476,000 per share based on an analysis of its cash flows projected into the future and discounted back in time.
One of the most important aspects is that Greg Abel says he will continue the current culture at Berkshire Hathaway when Warren Buffett steps down. That’s likely a huge relief to everyone involved since the company’s success is largely built on careful analysis and prudent spending.
Assuming that Abel keeps his word, investors have every reason to believe that Berkshire Hathaway shares could resume growing at a rate faster than the overall market.
Should You Invest in Berkshire Hathaway?
Considering that one A share of Berkshire Hathaway costs more than $400,000, though, it’s safe to assume that few investors can buy-in but the B-shares are trading at a fraction of the cost, just a few hundreds bucks a share.
There are other ways to follow Buffett by investing in the companies he prefers. Apple costs north of $100 per share. Practically any investor can afford that. Coca-Cola typically trades for north of $50 per share. These are investments that you can add to your portfolio for stability and growth. Once you earn enough by following the bold moves of a man willing to spend $12 billion on one stock, perhaps you’ll have enough to invest in Berkshire Hathaway itself.
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