Buffett Buyback Means S&P 500 May Be a Value

By Whitney Kisling and Nikolaj Gammeltoft - Sep 28, 2011 3:48 AM GMT+0700
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Berkshire Hathaway CEO Warren Buffett attends the Fortune Most Powerful Women summit at Mandarin Oriental Hotel on October 5, 2010 in Washington. Photographer: Jemal Countess/Getty Images for Time Inc.

Warren Buffett’s determination that Berkshire Hathaway Inc. (BRK/A) shares are cheap enough to buy back may mean the Standard & Poor’s 500 Index is also a bargain.

The company is authorized to repurchase stock for the first time in four decades as long as its price is less than 1.1 times book value, or assets minus liabilities, according to a statement yesterday. The level is 29 percent below Berkshire’s average of 1.55 since 2000, almost the same discount investors are getting in the S&P 500, according to data compiled by Bloomberg. Shares of Omaha, Nebraska-based Berkshire fell to $100,000 for the first time in almost two years on Sept. 22.

Declines that have erased about $2.8 trillion from the value of American equities in the last two months are luring Buffett, who said his company spent more to buy stocks on Aug. 8 than any other time this year. The S&P 500 tumbled 6.7 percent that day and has lost 15 percent from its 2011 high on April 29, driven down by concerns Europe’s debt crisis will spread and shrink the global economy. The benchmark index rose 1.1 percent to 1,175.38 today.

“If he thought the possibilities of a recession were on the horizon, then he’d wait to do this,” James Dunigan, who helps oversee $109 billion as chief investment officer in Philadelphia for PNC Wealth Management, said in a telephone interview. “You can make a number of arguments that on some traditional measures, the market is undervalued.”

Buffett didn’t respond to an interview request e-mailed to his assistant, Carrie Kizer.

Market Valuations

Repurchasing Berkshire stock is a bet that market valuations are too low partly because so many of its investments are public, Mark Luschini, chief investment strategist at Philadelphia-based Janney Montgomery Scott LLC, which manages $54 billion, said in a telephone interview. Berkshire owns stakes in 27 companies whose trading is overseen by the U.S. Securities and Exchange Commission, an August filing showed.

“This announcement is a bit out of character and for that reason is seen as very constructive both in terms what he sees as an opportunity to buy a great asset, namely Berkshire stock, trading at a discount to historical book value as well as the portfolio of companies within Berkshire that he thinks is undervalued,” Luschini said.

The plan may signal that Buffett, Berkshire’s chairman and chief executive officer, is finding fewer opportunities in the stock market, said Michael Shaoul, who helps oversee more than $1 billion as chairman of Marketfield Asset Management in New York. While the S&P 500 is priced close to the same discount to its historical book value as Berkshire, fewer than 20 percent of its companies are trading below the 1.1 ratio Buffett requires for his own repurchases, data compiled by Bloomberg show.

‘Not a Dime’

Buffett previously preferred to use profits to buy companies and securities issued by others. “Not a dime of cash” has been spent on buybacks or dividends in four decades, the billionaire told investors in his annual letter, published on Feb. 26. Buffett invested $5 billion in Goldman Sachs Group Inc. (GS) and $3 billion in General Electric Co. in 2008 when the Lehman Brothers Holdings Inc. failure cut companies off from traditional sources of funding.

Goldman, CME

Decatur, Illinois-based Archer-Daniels-Midland Co. (ADM), the biggest U.S. grain processor, Goldman Sachs, the New York-based securities firm, Chicago-based CME Group Inc. (CME), the largest futures exchange operator, and 89 other companies have price-to- book multiples below 1.1, the data show. Excluding intangible assets, such as goodwill, 47 of the 500 companies in the benchmark U.S. equity gauge meet the criteria.

“It could be argued that if the market is cheap in his view, he could find something else to buy instead of his own stock, since making timely acquisitions was the way he built up his company in the first place,” Shaoul wrote in an e-mail. “I am sure that is the question most people are asking.”

Comparing a stock’s price to book value may not be the most reliable valuation technique because assets reflect estimates that may not prove accurate, Malcolm Polley, who oversees $1 billion as chief investment officer at Stewart Capital in Indiana, Pennsylvania, said in a telephone interview.

“Analyzing book value is a difficult way to determine the relative worth of a company,” he said. “It’s because of a lot of intangibles that you really don’t know what the value is. It’ll give you an idea about the trend.”

The S&P 500’s book value fell from about $533 a share in May 2008 to $442 a share in March 2009, monthly data compiled by Bloomberg show. The decline occurred as banks and financial companies were in the process of writing off more than $2 trillion in loans tied to subprime mortgages, the data show.

Matching Berkshire

Lowering the S&P 500’s price-to-book ratio to match Berkshire’s would cut the index’s price by 42 percent, data compiled by Bloomberg show. The benchmark gauge for American equity has combined book value of $611.38 a share, based on the most recent filings of its companies. Cutting the multiple from 1.9 to 1.1 would send the S&P 500 to about 673 from 1,162.95, according to data compiled by Bloomberg.

Berkshire’s Class A shares dropped 17 percent to $100,320 apiece in 2011 prior to the buyback announcement. They were trading at 16.3 times earnings as of Sept. 22, the lowest price- earnings ratio of 2011, according to data compiled by Bloomberg.

“The underlying businesses of Berkshire are worth considerably more than this amount,” the company said yesterday in a statement. “If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares.”

Railroad Acquisition

Buffett bought railroad Burlington Northern Santa Fe last year for $26.5 billion in what he described as an “all-in wager” on the U.S. economy. In July, Buffett told Bloomberg Television he expected economic growth to continue and would “bet very heavily” against a second recession in three years.

Buffett said his company spent more on stocks on Aug. 8 than any day this year, when the S&P 500 tumbled 6.7 percent, the most since December 2008. “I like buying on sale,” he said in an Aug. 15 interview with Charlie Rose broadcast on PBS.

Last week’s rout erased $1 trillion from U.S. equities amid concern Greek insolvency is inevitable and Europe can’t contain the damage. The S&P 500 last week was trading at 12.4 times earnings in the past 12 months, 4.6 percent below its average valuation at the lowest point during the last nine bear markets, according to data compiled by Bloomberg.

“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,” said Eric Green, a Philadelphia- based fund manager at Penn Capital Management which oversees about $6 billion, said in a telephone interview. “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.”

To contact the reporters on this story: Whitney Kisling in New York at wkisling@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net.

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net