Warren Buffett and Charlie Munger hope for one thing when a company they own repurchases shares. They hope for the price of the company to, as Buffett says, "languish." In Buffett's 2011 letter to Berkshire Hathaway shareholders he gave a great explanation on why it is better for IBM's (IBM) price to "languish" while the company repurchases shares.
"Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company's earnings over the next five years if of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during this period?
I won't keep you in suspense. We should wish for IBM's stock price to languish throughout the five years.
Let's do the math. If IBM's stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the "disappointing" scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $1 1/2 billion more than if the "high price" repurchase scenario had taken place.
The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply."
Owners of businesses rarely worry about the daily price of their company unless the price is to their benefit. Buffett and Munger, with their ownership mindset, see how a sustained low price of IBM allows them to acquire more of a great company. Many might argue that languishing prices would do no good if they continue to languish, but Buffett and Munger know another thing, if the business does well the stock price eventually follows. Notice how Buffett mentions a 5 year time frame which is much longer than the average holding by most, but small in comparison to his time frame of forever.
IBM has been a company that has been around for over a hundred years and even though they have had their hiccups, over the last ten years they have been able to compound operational profit at an annual rate of 12%. IBM has not had the stellar returns of other technology companies but they have been more consistent with returns and has been share holder friendly. With a combination of their contract structures, higher margin software, product development and customer relationships, IBM possesses a large competitive advantage that gives them the ability to keep prices high and the competition away. So, if IBM can continue to perform well and be as shareholder-friendly as they have been, the price of the stock will eventually rise in step with performance. If the price of IBM languishes for the next five years, market fluctuations will be your friend and not your enemy. You will be able to buy the company directly or indirectly for a cheaper price, giving you a larger ownership in a great company. Surely if you invest for the short term, languishing prices will do no good as you dance in and out of the stock.
Maybe it's easier for Buffett and Munger to think the way they do because they own sizable chunks of companies while everyone else might own a minuscule percentage of any company. The same thing is true, though; everyone who invests in a company is part owner, no matter how small the ownership. When one thinks like an owner, they become an owner.
For owners of great companies, such as IBM, look at market fluctuations as your friend and not your enemy. If IBM's stock price languishes, which as a long-term owner I hope it does, then shareholders will be rewarded much more handsomely in the long run than if the stock price stays high. Maybe it would be wise to join Buffett, Munger and the other 2%'s corner of the tent who profit from Mr. Market's madness. Be jolly knowing that the other 98% will participate in Mr. Market's folly.
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