For Buffett, the central question facing any business is what to do with each dollar it earns but does not need to run in place: reinvest it, buy back stock, or pay it out. His test is unsentimental - retained earnings are only worth keeping if the business can turn each dollar into at least a dollar of value, and buybacks make sense only when the stock trades below intrinsic value. These passages trace that discipline across three decades, from the arithmetic of retention to his warnings about buybacks done for fashion rather than value.
The value to Berkshire Hathaway of retained earnings is not determined by whether we own 100%, 50%, 20% or 1% of the businesses in which they reside. Rather, the value of those retained earnings is determined by the use to which they are put and the subsequent level of earnings produced by that usage.
Once an informed guess is made, the rest of the analysis is simple: you should wish your earnings to be reinvested if they can be expected to earn high returns, and you should wish them paid to you if low returns are the likely outcome of reinvestment.
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.
Obviously, the future results of a business earning 23% annually and retaining it all are far more affected by today's capital allocations than are the results of a business earning 10% and distributing half of that to shareholders. If our retained earnings - and those of our major investees, GEICO and Capital Cities/ABC, Inc. - are employed in an unproductive manner, the economics of Berkshire will deteriorate very quickly.
When managers are making capital allocation decisions - including decisions to repurchase shares - it's vital that they act in ways that increase per-share intrinsic value and avoid moves that decrease it. This principle may seem obvious but we constantly see it violated. And, when misallocations occur, shareholders are hurt.
It appears to us that many companies now making repurchases are overpaying departing shareholders at the expense of those who stay. I can't help but feel that too often today's repurchases are dictated by management's desire to "show confidence" or be in fashion rather than by a desire to enhance per-share value.
Buffett in his own words on camera. Transcribed from the interview; click through to watch the moment.
Since Wells repurchases their shares and we were right up against 10%, we went over, because they repurchase shares, not because we bought. So we will sell enough to stay at around nine point eight.