NEW YORK (
Billionaire investor Warren Buffett in his annual letter to shareholders praised
CEO Jamie Dimon for his position on buybacks, which is ironic, considering that Dimon ended up apologizing to shareholders last year for the company's poorly-timed share repurchases.
"One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan; I recommend that you read his annual letter," Buffett wrote.
In his annual letter last year, Dimon clearly said the bank would use capital to buy back stock only after exploring opportunities to invest in organic growth and make acquisitions. "As a discipline, we always will buy back the stock we issue for compensation," Dimon wrote. "However, we will buy back additional stock only when, looking forward, we see few opportunities to invest in organic growth and acquisitions. And we will buy back stock only when we believe it benefits our remaining shareholders - not the ones who are selling."
Despite the lofty standards for buybacks, the bank went ahead and spent $8 billion in share repurchases in 2011, using excess capital to shore up the stock price as it continued to trade at discount to historical valuations. But the shares continued to plummet and the repurchases proved to be ill-timed.
Dimon admitted as much to shareholders during the third quarter conference call, saying that it "would have been
wiser to wait " and that the company was "sorry".
Banks including JPMorgan,
and other big banks are expected to make more buybacks in 2012, as they find fewer organic growth opportunities and M&A opportunities remain limited.
Investors are waiting for the
to announce the results of its annual stress test on the biggest banks in March, to get more clarity on banks' capital return plans.
Banks have shown an inclination towards buybacks over dividends in recent quarters, though given the run up in share prices recently, that might change. Some
analysts have decried the use of capital towards buybacks.
Rochdale Securities analyst Dick Bove says banks have historically made ill-timed investments in buybacks, repurchasing shares when the stock is at relatively high prices, only to end up raising capital when shares are at very low prices.
"The industry is a cyclical industry; not a growth industry. It needs capital at the bottom of cycles and does not need capital at the top. Thus, it buys in at the top and sells out at the bottom," Bove explained in a note last year, a strategy that pays off for shareholders who sell out but is a bad idea for the companies themselves.
"Investors seeking stock buy backs are asking the banks to "run close to the wind" - i.e., drop their leverage ratios to points where an economic set back will require the sale of more stock," says Bove. "They are asking banks to do exactly what their regulators do not want them to do.
Buffett's own feelings about buybacks are mixed. After being a critic of the practice, the CEO announced last year that
would buy back stock at 110% of book value and ended up buying $67 million in stock after which the price ran up.
Buybacks make sense when two conditions are met, according to Buffett. The company has sufficient capital to meet conditions and two, the stock is selling at a material discount to the company's intrinsic business value, conservatively calculated.
The legendary investor still says that too many bouts of repurchases have been misguided as "many CEOs never stop believing their stock is cheap."
"The first law of capital allocation - whether the money is slated for acquisitions or share repurchases - is that what is smart at one price is dumb at another," Buffett wrote.
Still, in his characteristic style, the investor made a contrarian argument why shareholders in companies with buyback plans should want their stocks to "underperform."
His logic is simple. Companies with buyback plans acquire more shares at a lower price, thereby offering long-term shareholders a greater stake in the company and in future earnings. You can read
how the math works here.
So if you are a long-term shareholder in JPMorgan and other bank stocks, don't worry if the buybacks in the near-term do not automatically pay off. Your share of future earnings are higher if the bank purchases shares when the stocks are languishing, not when they start to rise.
--Written by Shanthi Bharatwaj in New York
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