Disappearing Buybacks?
December 26, 2009
– Comments (11) |
RELATED TICKERS: PEP
It's a tricky world out there. There always seems to be new things to have to be on our guard against. They don't always have to be new,either...
Sometimes they're more established, even having become something "everybody knows", part of the conventional wisdom that many people just accept without further investigation. So some people may never make an effort to uncover the truth.
The truth about share buybacks is that they may not be such a wonderful deal for shareholders. I want to cast some doubt. I want to poke some holes in what many people believe is a great way for a company to add value to their stock.
They tell us that the earnings pie is cut into fewer pieces after a buyback, which raises earnings per share and adds value.. They tell us that share buybacks are better than dividends because of the double taxation.
Sure, just throw the money away, that way I won't have to pay any taxes on it.
Things are not always what they seem. I won't just tell you why I don't like share buybacks. I will also give you some numbers. Numbers that you can also check against your own companies. You might be surprised what you may find out.
First, my rant.
I believe share buybacks are usually complex and expensive. Of course they're expensive! Companies repurchase shares during times that they're making the most money, when the economy's doing well. These just also happen to be the times that share prices are high and very likely selling at a premium.
I believe share buybacks are devious, and of negligible value to shareholders. Too many end up being reissued to company management as excessive compensation. Shares reissued to executives and others who have options and stock grants in their compensation package are not a return of capital to shareholders. They are not removed from the float.
Do companies that engage in share buybacks outperform those that don't? Is there a noticeable effect on EPS or FCF? Or is the convoluted path they take from the market through the treasury stock account to the stock options/grants for senior executives and board members simply a purposely complex trail meant to disguise share dilution due to executive over-compensation?
I have some shares in PEP. Between 2003 and 2007 PEP spent $10,298B on share buybacks. Share count was reduced from 1.705B in 2003 to 1.605B in 2007. So did $10.298B buy only 100M shares? The numbers say this is $102.98 a share. The record says that PEP never approached $100 a share during that time frame. Did I get value out of that share repurchase? If I did, I'm sure it was mighty small and the shares that weren't given away were still bought at a premium to their value. I doubt very much if value was created. More likely it was destroyed.
Of course, sometimes shares are hoarded in the treasury stock account and used for acquisitions, which often aren't that great a use of the company's capital either. Organic growth from within is usually much more positive for return on equity than trying to buy it. They never get a good deal on acquisitions, do they? That's why there has to be an accounting for the premium paid in the form of goodwill on the balance sheet. So then you have shares that were overpaid for being used to enter into a transaction where the company also has to pay a premium for the value it's getting. How much value was created there?
All that being said, companies that generate far more cash than they can realistically reinvest in their core business can't just send all the excess out as dividends. I know that. By paying some out as dividends and using some to buy back shares, they have more choices to manage their way through hard times like this last year. Many never did cut their dividends, but they could choose to halt their share buyback plans without any real repercussions.
Companies do have to do something with the excess cash they generate. A company that has a return on equity of 25% can't realistically expect to grow at a 25% rate for very long (or at all, if it's a mature company and already very large). But I feel the conventional wisdom we're all fed about share buybacks is for the most part nonsense.
And in any comparison of the two I'd rather have cash any day than have my company waste money for me. I can do that myself. A larger piece of the earnings pie? Please. They can play earnings like a guitar. They can't do that with dividends.
Check some of your own holdings. See if you, too, had share buybacks where the math doesn't add up. I bet you do.....
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