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Buffett Knocks Down Bar For Investing in Berkshire

Some Background on Stock Splits

What are stock splits?

When a split is declared by a company, each share is split up to create additional shares. For example, in a thirty-for-one stock split, each share is split into thirty new shares.

Do stock splits make sense?

Academicians do not yet have a model to explain why firms actually split their stocks. Proponents of stock splits argue that a security has a proper trading range. A security whose price is above this range would not be affordable to many investors. This is not a very convincing argument for at least two reasons: (1) Companies do not have to be concerned with affordability on the secondary markets (exchanges) since the transactions involve exchange of ownership and not the infusion of new capital to the company. (2) More than 80% of the trading volume on the NYSE is institutional (i.e., by mutual funds, pension funds, insurance companies, and other large investor groups).

Another argument for splits is increasing liquidity. There is evidence, however, that stock splits may actually decrease the liquidity of the company’s shares. Following a two-for-one split, the number of shares traded should more than double if splits increase liquidity. There is no support for this argument, and the reverse is sometimes observed.

Article Specifics:

"The billionaire Omaha, Neb., investor surprised investors by unveiling a plan that would let Berkshire Hathaway Inc. stockholders convert each of their high-priced shares - which closed at an unwieldy $31,700 a share yesterday, down $200 - into 30 shares of a new class of stock.

‘We’re giving shareholders a do-it-yourself split, if they care to do it.’" Mr. Buffet was quoted as saying.

"Under Berkshire’s plan, the holding company will create a new Class B common, and designate the existing shares as Class A stock. Class A holders will be able to convert their share into 30 shares of Class B - but shares can’t be converted back into Class A."

" The new shares have some drawbacks. They would have just 1/2000th the vote of a Class A share, instead of 1/30th. And they wouldn’t qualify for Berkshire’s charitable-contributions program, under which stockholders can designate charities to which they want Berkshire to contribute."

So what is Buffet’s motivation?

For starters, the new $1,000 does not sound affordable, especially when one can participate in a mutual fund with sometimes as little as $100. Second, the Class B holders lose on voting rights, thus should have a lower value than 1/30th. Third, even if there was some merit to the liquidity argument, it seems dubious here since not all the existing shares would be converted to the new class. In some fairness, Berkshire plans to issue at least $100 million of new shares to ensure that enough Class B shares exist to qualify for listing (trading) on the New York Stock Exchange (NYSE).

The article explains that Berkshire’s motivation for the split is a ‘reluctant response’ aimed at other unit trusts that let "small investors piggyback on Berkshire’s success," by investing directly in Berkshire stock and Buffett favorites [such] as Coca-Cola and Gillette. So how would this benefit existing Berkshire investors? I am not sure. Actually it might make the market for Berkshire Class A stocks even less liquid.

Follow Up

It would be interesting to see how many shareholders convert to Class B, and at what price, compared to Class A shares, would they trade at.

Source: WSJ, 2/14/96, p. C1

By Alex Tajirian