Share repurchases return on capital

[widenthemoat]

I was recently reading through the 2011 Berkshire Hathaway Letter to Shareholders and I wanted to walk through the IBM share repurchase example that Warren gave in it. I am trying to find out the "return on capital" from spending money on buybacks and I did this by basically comparing the scenario that Buffett described in the letter to a scenario in which no buybacks occurred. Is it correct to say that since Berkshire owned about 5.5% of shares outstanding before any repurchases occurred the cost for Berkshire to repurchase these shares was $2,754,310,345 ($50 billion x 5.5%) while the return on this investment is the difference between the "With Repurchase" and "Without Repurchase" earnings that Berkshire owns of $302,671,466 ($1,404,395,604 - 1,101,724,138)? Overall if I am looking at this correctly one could argue that the return on capital for the buybacks was $302,671,466/$2,754,310,345 or 10.99%. Any insights into this exercise would be much appreciated and I know how knowledgeable everyone on this board is so I figured I would see if anyone could point out some errors in my reasoning.

 

http://www.berkshirehathaway.com/2011ar/2011ar.pdf

 

With Repurchases

Original IBM shares outstanding: 1,160,000,000

Berkshire shares owned: 63,900,000

Total cash used for buybacks: 50,000,000,000

Berkshires ownership % used for buybacks: 2,754,310,345

Average stock price over 5 year period: 200

Shares acquired: 250,000,000

Ending IBM shares outstanding: 910,000,000

Ending IBM earnings: 20,000,000,000

Berkshires ownership % of ending earnings: 1,404,395,604

 

 

Without Repurchases

Original IBM shares outstanding: 1,160,000,000

Berkshire shares owned: 63,900,000

Total cash used for buybacks: 0 

Berkshires ownership % used for buybacks: 0 

Average stock price over 5 year period: 200

Shares acquired: 0 

Ending IBM shares outstanding: 1,160,000,000

Ending IBM earnings: 20,000,000,000

Berkshires ownership % of ending earnings: 1,101,724,138

[Tim Eriksen]

To me it is a reasonable back of the envelope calculation.  Obviously if they spend $50 billion in the repurchase scenario then the non-repurchase scenario has $50 billion that will either be used to pay down debt, earn interest (not much in today's interest rate environment), or be paid as a special dividend.  In other words the non-repurchase scenario will likely have higher earnings (net income not EPS) or has to include special dividends.

 

The biggest problem in this specific case is IBM has declining year over year revenue and net income.