Stock Buybacks: A Good Thing...If The Price Is Right

From this Barron's article:

PUBLICLY TRADED COMPANIES generally face two choices when their cash exceeds reinvestment needs: Pay shareholders via dividends, which are double-taxed, or buy their own shares in the market, increasing the company's value to remaining shareholders.

What's a sensible use of capital at one price naturally becomes not so sensible at some higher price.

Well, buybacks are only a good thing if consistently executed when the stock price is below -- and, ideally comfortably below -- per share intrinsic business value.

They also only make sense if company finances are in good shape, the routine needs of the business are well-covered (enough to at least maintain competitiveness), and that no other action (including those things that widen the all-important moat) provides, considering the specific risks, a better return.

When a buyback is announced, it is frequently greeted with cheers. When done the right way, a buyback can certainly end up being a very good thing for shareholders. Other times, buybacks are executed for the wrong reasons (i.e. to offset the dilution resulting from exercised stock options, for example) or when shares are expensive.*
(Sometimes buyback announcements end up being little more than that...words that end up not being followed by wise action.)

A study of companies (primarily technology) and their share repurchases reveals, at best, mixed results.**

It shows that, while some buyback programs have delivered favorable results, a large percentage have not been effectively implemented and delivered weak results for shareholders. The article points out that managements have a tendency to execute more buybacks during the good times and less when times are tough. Well, that behavior almost certainly leads to paying, at best, more than necessary, or worse, maybe even a premium to per share intrinsic value.

The study was of $ 457.6 billion in buybacks from 2000 through 2012 of 232 companies. According to the study:

- 75% of the 232 companies bought back stock.
- They paid 39% of their current market value for buybacks.
- At the end of 2012, 51% of the programs are now profitable while the rest, of course, were still not.
- The shares are worth just 13% more than what they cost to repurchase for the group. Not a disaster, maybe, but hardly an acceptable result considering it has been over a 13 year period.
(It's worth noting that this is based on market prices. Again, what really matters is what was paid compared to per share intrinsic business value.)

The article also points out that this doesn't include the foregone interest on the cash if the shares had not been bought back. For that and other reasons the 13% is actually an overstatement.

So, according to the article, here's who did the best buying back shares among the larger cap stocks in the study:
  • Verisign (VRSN) - The internet-registry service bought 165 million shares for, on average, $ 27.55. That comes to a total of $ 4.6 billion spent on buybacks. As I write this, shares of the company are currently trading at $ 47.45. So, if the company's not overvalued, it would seem that the buybacks have worked out just fine for continuing shareholders.
...and here's who did the worst:
  • Dell (DELL) - The company spent just under $ 36 billion -- much more than the entire company's current market value -- to buy nearly 1.3 billion shares at an average price of $ 27.79. Shares currently sell at around $ 13.40. Michael Dell and Silver Lake Partners have offered to buy the company for $ 13.65 per share, less than half that average share repurchase price. The battle to buy the company continues. Whether the deal goes through or not near the currently offered price, these buybacks have proven to be very costly. It's even worse when one considers what else could have been earned with that $ 36 billion during all this time.
So buybacks can be a very good thing but, unfortunately, one cannot assume they will be done in a way that is highly beneficial to shareholders.

That's why -- all else equal -- a firm led by someone with wise capital allocation skills has higher intrinsic value even if that additional worth is difficult to quantify.

Adam

* A good explanation of when it is advisable to buyback stock and when it is less so is in the Share Repurchases section of the 1999 Berkshire Hathaway (BRKaShareholder Letter.
** By advisory service MG Holdings/SIP.
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Stock Buybacks: A Good Thing...If The Price Is Right
Stock Buybacks: A Good Thing...If The Price Is Right
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