Buffett ‘Put’ Gives a Hint of What’s Coming

One of the biggest questions surrounding Berkshire Hathaway stock has been what happens the day Warren Buffett retires or gets hit by the proverbial truck.

Now we know the answer. The stock will trade at least 10 percent higher than Berkshire's book value, or roughly what's left after liabilities are subtracted from assets.

We can infer this from Berkshire's open-ended share repurchase plan, in which it may buy back stock any time the shares fall below 110 percent of book value as long as the company has $20 billion in cash and equivalents on hand.

Among the reasons Berkshire cited for the buyback plan was the recent stock price -- $100,000 for the Class A shares -- which the company said was considerably less than the value of its underlying businesses. The A shares rose 8.1 percent on Sept. 26, the day of the announcement, to $108,449. The stock closed at $106,500 yesterday.

Buffett wants Berkshire's stock price to reflect its "intrinsic value," which in his opinion should be a premium to stated book value. But this has never been a reason for a share buyback before. Buffett has always cited other, better opportunities, or the need to hold dry powder for when they might appear.

Even during the worst of the financial crisis from September 2008 to March 2009, when Berkshire's stock fell by 50 percent, the company didn't start a buyback. Only once in the past four decades, in 2000 at the peak of the Internet bubble, did Berkshire offer to repurchase shares. In the end, it didn't because the announcement drove up the stock price so much.

‘Not a Dime'

In January 2010, Buffett said the shares were undervalued and regretted having to use them for the stock portion of the $34 billion acquisition of Burlington Northern Santa Fe. In his latest shareholder letter this February, Buffett made it a point of honor to say that "not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years."

Now that Buffett has done it, the main effect is to set a floor under the stock. Although book value is subject to market fluctuations, Berkshire's existing businesses over time will grow, increasing book value. Think of it this way: An option to sell, or "put," the stock back to Berkshire at 110 percent of a rising book value is dear -- assuming, of course, that the company does go ahead with repurchasing shares. This again raises the question of why Buffett would make such a commitment simply because the stock is undervalued today. (more)