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27-02-2024 : Warren Buffett's 2024 annual letter to shareholders

In this letter, Warren Buffett points out that what creates value is a company's ability to reinvest its profits at a rate of return higher than its cost of capital. Conversely, a company that reinvests its profits at a rate of return lower than its cost of capital destroys value. This explains why the share price of these companies jumps when their managers promise significantly higher returns. 

Barclays, for example, has just promised to return £10bn to its shareholders over the next 3 years (on a market capitalisation of £23bn). The share price has jumped by 10%. Not that shareholders are dividend-hungry leeches. It's just that they know how to count. To understand this, you need to remember that Barclays' equity of £71bn is only worth £23bn on the stock market, the result of Barclays' return on equity (7.3% in 2023) being lower than its cost of capital for years. This represents a 68% discount and a £48bn loss in value. 

10bn of dividends paid means £10bn of cash reaching shareholders' accounts and being worth £10bn. It also means a £10bn reduction in book equity, which at a constant 62% discount means a reduction in equity value of only £3.8bn. In net terms, +10 - 3.2 = +6.8. 

On the other hand, £10bn of reinvested earnings means a £10bn increase in the book value of shareholders' equity and a £3.2bn increase in its value at a constant 32% discount. 

+ 6.8bn if Barclays returns £10bn to shareholders, versus +£3.2bn if Barclays reinvests the £10bn in its business, whose marginal profitability is lower than the cost of capital, leading to a loss of value. No wonder shareholders are applauding with both hands. Especially as there could be a second-round effect, as at least 60% of the returns will take the form of share buy-backs, leading ipso facto to an increase in shareholders' equity per share, and at a constant discount, a corresponding increase in the share price.

On the other side of the Atlantic, once again this year, Berkshire Hathaway shareholders will overwhelmingly vote for no dividend, preferring reinvestment, confident in their leader's ability to generate returns in excess of the cost of capital. 

Having said that, Warren Buffett warns that Berkshire Hathaway's size ($900bn) means that its future performance will no longer be as exceptional as in the past. 

The day when Berkshire Hathaway will pay dividends is not far off; probably after the death of its founder, just as Apple waited until the death of Steve Jobs to do so, such is the power of these exceptional men. 


17-02-2024 : Uber and share buybacks

 On the occasion of the publication of its 2023 results, the first to show positive net income ($1.9 billion), Uber announced the launch of a $7 billion share buyback plan.

Why initiate share buybacks when the group still has a net debt of $5.8 bn, i.e. 3 times EBITDA (or 1.5 times if we consider share-based compensation expensed as a non-cash expense)? Admittedly, Uber is announcing growth rates for the next 3 years of between 15/20% and cash flow growth twice as strong, which makes doubts about its ability to meet its debts irrelevant.

So, it's not a case of idle, surplus capital, as with Apple or Google. Nor is it that the stock is grossly undervalued - that's not immediately obvious at 50 times operating cash flow minus tangible investments. These are the two most common reasons for share buybacks. The issue is rather the growth in the number of shares.

Indeed, like virtually all technology groups, Uber compensates its employees through the granting of free shares, averaging $58k in 2022, but probably much, much more for employees in the key R&D and Technology department, which accounts for $1,215m of the $1,935m in share-based compensation booked in 2023. Since the share-based compensation of these employees accounts for 38% of the department's costs, their share of compensation is likely to exceed half of their total compensation, and therefore exceed the amount of their salaries paid in cash.

A share price that has doubled since the 2019 IPO is a blessing for everyone (sorry, short sellers), but the day a bearish phase sets in, some in the R&D and technology department will look sadly for greener pastures, as soon as the downward price movement is not general, but specific to Uber.

Since the IPO, the number of Uber shares has grown by an average of 5% a year, due to this effect and to the payment of external growth operations in shares. Buying back shares limits the growth in the number of shares, which would otherwise reduce the growth rates of operating parameters and threaten a good valuation. This shows a discipline that appeals to investors, and is the strength of this convention to which Uber has just adhered (in its own best interests).

PS: for those who believe that share buybacks boost share prices. The $7 billion announced by Uber, assuming it is fully realized in 2024, would represent only 2.4% of the average daily volume of transactions on the share. Not enough, in itself, to boost the share price mechanically and significantly. And academic research shows that the idea that share buybacks will boost share prices is false.


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The Letter

Number 155 of February 2024

News : Trials and tribulations of a start-up

Statistics : Corporate income tax rates

Research : ESG in SRI? Not in the US

Q&A : What is the rule of forty?

COMMENTS : Comments posted on Facebook