You would swear it is just a matter of common sense, but it isn’t. Buffett’s announcement of a share buyback for the first time ever this fall was big news. Of course Warren “gets” it. You buy back shares when your stock is exceptionally cheap. You stop buying when it is no longer undervalued.
In reality many companies buy most aggressively when they have lots of cash coming in, and slow down when it isn’t. This generally means they are buying in good economic times when stock prices are high, and not buying when they should be, which is when the economy is tough.
I guess there is simply a lot of pressure to not hold cash. The result being poorly timed buybacks and questionable acquisitions.
Below is a great success story of a small Canadian company who employed this common sense strategy to the benefit of shareholders;
Mystery of BMTC stock's great success? It's elementary
By PETER HADEKEL, The Gazette July 21, 2010
It can be a fascinating exercise to look at how and why a particular stock manages to deliver exceptional returns to shareholders.
John Ewing, director of research at Burgundy Asset Management, became intrigued with the performance of BMTC Group Inc., a small-cap furniture retailer that operates under the Brault & Martineau and Ameublement Tanguay banners.
Now, like me, you've probably heard plenty of Brault & Martineau commercials on the radio and maybe even bought a sofa there. But you probably didn't realize that BMTC stock has been an outstanding performer over the last decade.
Ewing calculates that from 2000 to 2009, the total return to shareholders was 1,300 per cent, or about 30 per cent a year, compared with 73 per cent, or 5.6 per cent annually, for the S&P TSX composite index.
If you had invested $10,000 in the company's shares in 2000, you would have received a total compounded return including dividends of $140,000 over that period. That compares with a $17,000 return from the same investment in the TSX index.
Furniture retailing is not usually considered a sexy growth industry, like software or telecommunications. So what accounts for this success story?
As Ewing notes, growth does matter. But many companies pursuing growth strategies do not deliver good returns for shareholders.
While BMTC did expand the number of its warehouse stores and smaller outlets, its total revenue growth of about 51 per cent during the decade was not overly impressive. There had to be more to the story.
Sometimes a stock benefits from the expansion of its multiple (the share price compared to the earnings per share). In BMTC's case, the stock traded at 7.8 times earnings in 1999 and at just 9.6 times earnings a decade later -a modest expansion that contributed only six per cent to the total return.
What about the profit margin? BMTC did manage to control costs and it more than doubled margins from 3.4 per cent in 1999 to 8.2 per cent in 2009. But while this did improve the bottom line, margin expansion accounted for only about one-third of the total return to shareholders.
Perhaps it was the way the company managed its capital?
Well, BMTC doesn't have any debt and hasn't invested in many new stores or acquisitions. The dividend was responsible for only about three per cent of the total return.
There's only one suspect left in this financial mystery: stock buybacks.
Many companies routinely buy back their own shares regardless of the price, but with little to show for it. BMTC was a shrewd buyer, spending as little as $9 million in 2000 and as much as $80 million in 2008 to purchase shares in the open market.
When the company did so, it was "acutely sensitive to price," Ewing noted. "The key is that they only bought back stock when it was cheap."
What happened is that stock buybacks reduced the shares outstanding by 50 per cent, leaving more equity in the hands of fewer shareholders.
Buybacks proved to be the single biggest component -43 per cent -of the total return to shareholders. In effect, shareholders who hung on to their stock were able to double their ownership stakes without spending an extra penny.
That kind of deal is "pretty rare," Ewing observes.
The formula might not work in every case, he adds. You'd be wary of stock buybacks if they occurred at a company where the earnings were constant and buybacks were the sole source of growth.
If a chief executive's compensation was tied directly to growth in earnings per share, buybacks might be made for the wrong reasons.
But the strategy made sense at BMTC because managers and insiders control the company and their own interests were aligned with those of all shareholders.
There were no obvious acquisitions to be made. Rather than diversifying into a different business, and maybe wasting money in the process, management kept its focus on improving the per-share value of the business.
It's a refreshing reminder: growth isn't just to be found on the top line or in high-profile acquisitions that burn capital. What really matters in the end is wealth creation for investors
