Wednesday, January 11, 2012

Jamie Dimon on Buying Back Stock

When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases. - Warren Buffett in the 1984 Berkshire Hathaway (BRKa) Shareholder Letter

Jamie Dimon of JP Morgan (JPM) said the following about buybacks recently. From this article in TheStreet.com:

...buybacks and dividend increases remain a board decision and that the bank will not buy back stock at any price. "Buying back stock makes sense when you are buying below intrinsic value. If you are buying above intrinsic value you are only benefiting exiting shareholder," he said, adding that he believes the bank's stock is cheap.

Good to hear "buying back stock makes sense when you are buying below intrinsic value" from a CEO. On too many occasions buying back stock is done for some other less economically sound reasons. Whether a buyback makes sense comes down to:

Are the shares are selling comfortably below a conservative estimate of intrinsic value?

Is the business in a financially and competitively strong position?

Are expenditures that maintain competitiveness (protect or enlarge the moat) still getting done?

Does buying back shares compare favorably, on a risk-adjusted basis, to alternative investments including high return expansion opportunities?

If the answer is clearly yes to questions like that, and intrinsic value has been estimated reasonably well (a rough estimate, of course, due to the necessarily imprecise nature of intrinsic value), then a buyback has a good chance of working very well.

What never makes sense is buying back shares when they are selling above intrinsic value though it certainly does happen.

Now, repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price. The shareholder who chooses to sell today, of course, is benefitted by any buyer, whatever his origin or motives. But the continuing shareholder is penalized by repurchases above intrinsic value. Buying dollar bills for $1.10 is not good business for those who stick around. 

Charlie and I admit that we feel confident in estimating intrinsic value for only a portion of traded equities and then only when we employ a range of values, rather than some pseudo-precise figure. - Warren Buffett in the 1999 Berkshire Hathaway Shareholder Letter

Seems incredible that buybacks were "all the rage" in 1999 when most stocks were unbelievably expensive. Of course, buyback activity was also intense leading up to the market peak in 2007.

This Barron's article points out the biggest year for buybacks was 2007 at $ 863 billion just as the market was at its peak.

So, all too often, shares are bought when they're selling plainly above intrinsic value. Also, buybacks sometimes used in an attempt to stem the decline or prop up the value of a stock. Not a good idea unless the stock happens to be selling nicely below intrinsic value at that time (just because the stock is dropping doesn't mean it's selling below intrinsic value) and the business is otherwise financially healthy enough with ample funds available:

We will never make purchases [ of Berkshire's stock] with the intention of stemming a decline in Berkshire's price. Rather we will make them if and when we believe that they represent an attractive use of the Company's money. - Warren Buffett in the in the 1999 Berkshire Hathaway Shareholder Letter

So a buyback should never be about influencing price action. It's about paying less than a dollar to get a dollar of value (a dollar of value that, if a good business, should grow) in return*.

On the other end of the spectrum is when a CEO has an extremely cheap stock but opts for an expensive acquisition instead.

That pretty much sums up Sanofi's (SNY) purchase of Genzyme. Here's what Sanofi CEO Chris Viehbacher said about buybacks when asked on a conference call:

"I personally don't believe that buybacks add any shareholder value."

This Barron's article makes the point that buying back their own stock at 7x earnings instead of buying Genzyme at 20x probably makes more sense.

When executed intelligently, buybacks work very well and, just as importantly, can reveal whether management actions are driven by shareholder wealth creation.

By making repurchases when a company's market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management's domain but that do nothing for (or even harm) shareholders. - Warren Buffett in the 1984 Berkshire Hathaway Shareholder Letter

The track record of effectively executed buybacks is certainly mixed at best but buybacks are neither inherently good nor bad. Careful consideration of the specific circumstances is always required.

I think that's worth remembering when a generalization is being made about the merits of repurchases (or the lack thereof).

Adam

Long BRKb and JPM

Related posts:
How Not to Spend $ 18.5 Billion
Sanofi to Buy Genzyme
Should Berkshire Repurchase Its Own Stock?
Buffett: When it's Advisable for a Company to Repurchase Shares
Berkshire Hathaway Authorizes Share Repurchases

* Let's say something like 70 cents is paid for a dollar of business value (as if it can be could be calculated with that kind of precision) but, of course, that dollar of value is not static. If a sound investment, that dollar in business value grows intrinsically over time. Of course, the opposite is true. Consistently judging reasonably well how value is likely to change over time matters. A discount provides only so much protection against mistakes.
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