90 THE WARREN BUFFETT WAY
with the shareholders. The ultimate test of owners’ faith is allowing
management to reinvest 100 percent of earnings; Berkshire’s owners’
faith in Buffett is high.
If the real value of dividends is sometimes misunderstood, the second
mechanism for returning earnings to the shareholders—stock repur-
chase—is even more so. The benef it to the owners is in many respects
less direct, less tangible, and less immediate.
When management repurchases stock, Buffett feels that the reward is
twofold. If the stock is selling below its intrinsic value, then purchasing
shares makes good business sense. If a company’s stock price is $50 and its
intrinsic value is $100, then each time management buys its stock, they
are acquiring $2 of intrinsic value for every $1 spent. Such transactions
can be highly prof itable for the remaining shareholders.
Furthermore, says Buffett, when executives actively buy the com-
pany’s stock in the market, they are demonstrating that they have the
best interests of their owners at hand rather than a careless need to ex-
pand the corporate structure. That kind of stance sends good signals to
the market, attracting other investors looking for a well-managed com-
pany that increases shareholders’ wealth. Frequently, shareholders are re-
warded twice; f irst from the initial open market purchase and then
subsequently from the positive effect of investor interest on price.
Coca-Cola
Growth in net cash f low has allowed Coca-Cola to increase its dividend
to shareholders and also repurchase its shares in the open market. In
1984, the company authorized its f irst-ever buyback, announcing it
would repurchase 6 million shares of stock. Since then, the company has
repurchased more than 1 billion shares. This represented 32 percent of
the shares outstanding as of January 1, 1984, at an average price per share
of $12.46. In other words, the company spent approximately $12.4 bil-
lion to buy in shares that only ten years later would have a market value
of approximately $60 billion.
In July 1992, the company announced that through the year 2000, it
would buy back 100 million shares of its stock, representing 7.6 percent
of the company’s outstanding shares. Remarkably, because of its strong
cash-generating abilities, the company was able to accomplish this while
it continued its aggressive investment in overseas markets.