In theory, reinvested dividends and net share repurchases are identical, because either way, the investor is acquiring a larger percentage ownership of the company. Differences in tax treatment can alter this balance, and more concerning, share repurchases can be done irregularly compared to typically regular dividends.
As a recent Credit Suisse research study showed, amounts spent on stock buybacks are heavily correlated to the stock market value. What this means is, companies in aggregate buy back more stock when stock prices are high, and less stock when prices are low. This is of course exactly the opposite of what we would want. I’ve pointed this out in numerous stock reports, but a study that is this comprehensive, with a chart that’s so concise, is among the most useful possible pieces of research on stock buybacks.
The study also showed several companies that made excellent use of share repurchases to produce market-beating returns. So it’s not a matter of “dividends are good, share repurchases are bad”. Instead it’s something that has to be determined on a case by case basis. More specifically, when a company is repurchasing shares when the stock is calculated to be below its intrinsic value (calculated via the Dividend Discount Model or some other cash flow method), then share repurchases can make sense, because the company is buying back at a good price and getting a good internal rate of return for EPS and dividend growth. But if a company tends to buy back overpriced shares (which is often the case), then it can be a poor use of cash.
Companies that Have High Shareholder YieldsWhen you add the amount spent on dividends in a year, and the amount spent on share repurchases over the same period, and you divide this sum by the market capitalization of the company, you get the shareholder yield. Personally, I prefer to use the net share repurchase figure for this, which subtracts the amount of value of shares issued.
The shareholder yield, expressed as a percentage, shows how much free cash flow goes to the shareholder as a combination of dividends and share repurchases. It also means that, if the company has zero growth and no change in stock valuation, this is the return the investor will receive. So any changes in core growth and stock valuation are applied onto the shareholder yield for the resulting total return.
Here’s a list of six companies from different industries that have bought back shares regularly, and have often bought back shares at fairly low stock valuations.
Microsoft (MSFT)Microsoft is a software company with a market capitalization of over $250 billion, and they are well-known for producing Windows, Office, Xbox, Bing, and a host of other products and services. With Windows 8 coming out, they’ll have an app marketplace right on millions of desktop PCs. They face strong headwinds from mobile, where they lack solid market share.
In terms of treating shareholders right, Microsoft has done a decent job. They pay a 2.60% dividend yield, and over the past seven years they have reduced the total share count by over 20%. Unlike many companies, they were aggressively purchasing their own shares in 2009 and 2010 during the bottom of the recession (among other years as well). Based on the 2012 figures, their shareholder yield is around 4.4%. Buying back shares when the P/E is 15 and the forward P/E is around 10 makes for at least a decent use of some cash.
Exxon Mobil (XOM)Exxon Mobil is the largest corporate oil company in the world, with a market capitalization of over $400 billion. The valuation is quote low, with a P/E of around 10. However, EPS predictions suggest the forward P/E is a bit higher, so along with other oil companies, the valuation is appropriately low. The company is a dividend aristocrat, but currently only yields 2.55%.
As far as share buybacks are concerned, Exxon Mobil does them largely and fairly consistently. Over the past seven years, they have reduced the total share count by approximately 25%, and the current shareholder yield is around 7.4%.
Walmart (WMT)Walmart has had a recent stock price surge. Over the past decade, EPS has been increasing like clockwork due to a combination of core growth and share repurchases, but the overvalued earnings multiple has steadily decreased, with the result being a perpetually flat stock price (which is what happened to Microsoft as well). It finally hit a point where the valuation was low enough for it not to be appropriate for it to continue decreasing, and so the stock finally had room to run again. Unfortunately, investors may have run a bit too quickly to it.
Regardless, the company has decreased the share count by approximately 18% over the past seven years, and currently pays a 2.15% dividend yield. The shareholder yield is over 4.5%. I’d look for a lower entry point, but it’s not unreasonable at this level, in my view.
International Business Machines (IBM)IBM is a 100+ year old technology company, with a focus that has shifted from hardware to a combination of software and services. I’ve been disappointed with IBM’s moderately high stock valuation, but during 2012 the stock has stayed flat while the earnings have continually inched upwards, and so I think the stock is back in fair value territory.
IBM’s total share count shrank by over 27% over the last seven years due to their large continual share repurchase program. The total shareholder yield is over 7.1%, even though the dividend yield is only 1.67%. Overall, I wish that IBM added 2% more to the yield instead of towards share repurchases, but overall, they’re growing their EPS and overall shareholder value to a reasonable degree by what they’re doing. Company-wide net income has increased by a 10.7% annualized rate over the last seven years, while EPS has grown by 16%, with the difference being due to the buybacks.
Philip Morris International (PM)Philip Morris is an enormous international tobacco company, and currently yields 3.55% (the highest on this list). Tobacco companies require little research and development, and in many markets are blocked from advertising, so often the only choice they have with most of their free cash flow is to use it to pay dividends or buy back shares.
The company currently has a shareholder yield of 7.6%. Although the stock is not undervalued by any stretch, I believe that there are solid risk-adjusted returns here based on the international exposure of the business and the addictive nature of their strongly branded products.
Chubb Corporation (CB)Chubb is an insurance company that has had slow growth over the last decade. They make optimal use of cash, so I use this company as an example in the Dividend Toolkit. Between 2004 and 2011, the company had essentially zero revenue growth, and yet returned 9-10% annually over the period through a combination of aggressively buying back its own stock and paying dividends. So just about all of the returns over this period were due to the shareholder yield.
During the low interest rate environment, management’s view expressed in an annual report was that there aren’t very many good investments out there for their portfolio, so their stock is one of the best investments they can find: hence aggressive share buybacks. The company has a dividend yield of only 2.16% (with an enormous string of consecutive dividend increases), but the shareholder yield is the highest on this list at around 9%.
ConclusionOverall, a number of reports show that companies generally mess share buybacks up. They do exactly what many investors do: buy more when stocks are high. The study earlier in this article is the most comprehensive report I’ve seen showing this to be the case.
When evaluating any company, especially a dividend stock, make sure you’re aware of their share repurchase history to see if it’s being utterly wasted or if it’s going to at least a decent use. Are they buying back stock irregularly or regularly? A key test is: what did they do during 2009? Were they buying back stock aggressively or no?
You’ll find that some companies, including many on this list, do share repurchases reasonably well. Overall, I’d prefer larger dividends over buybacks, but we have to work with what we can get, so it’s best to stick with companies that don’t squander shares too much, and instead stick to sensible buyback policies.
Full Disclosure: As of this writing, I am long MSFT, XOM, and CB.