Share count reduction - permanent shareholder value creation
This is another blog post on share buybacks. Evil share buybacks. Executive teams' method of hiding stock compensation. CFOs' secret way of artificially boosting EPS through financial engineering.
The sad fact is that because many large corporations' financial departments have given buybacks a bad name. And just maybe, rightfully so. But when done effectively, share buybacks are one of the safest, most powerful methods for companies to return value to shareholders.
So, how are share buybacks done effectively? By diluted share count reduction, of course!
When I read a Bloomberg, WSJ, The Motley Fool, or Reuters article on a company's quarterly performance, I commonly see items on revenue growth, net income growth, and EPS growth. But I rarely see anything on buybacks. Even if the author goes above and beyond the relative call of duty to report the amount spent on buying back shares, they almost never go as far to tell the reader how many shares - nominal or % - were actually reduced.
But share reduction is one of the most important means of increasing shareholder value.
Let's take 2 theoretical companies. We'll analyze their EPS after 10 years. Both companies start with $1M in earnings and 100K shares outstanding, yielding $10 EPS. Company A increases its earnings 10% every year, but its share count stays constant. Company B decreases its share count by 10% every year, but its earnings stay constant. (So from an earnings/share perspective, for one company we increase the top line by 10% every year, and for the other company we decrease the bottom line 10% every year.)
After 10 years, the comany with the earnings growth will be generating $25.9 EPS.
The company with flat earnings, but 10% reduction in shares per year: $28.7 EPS.
I realize this ignores the fact that the second company had burn cash in order to reduce those shares, but the counter argument is that the first company likely had to invest a lot of cash in order to generate 10% earnings growth per year. (That leads to another discussion on the wonder of high ROA companies...) Also, when a company spends $1B on share buybacks, its incredibly easy to analyze exactly how impactful those buybacks are. But when a company spends $1B on an acquisition or a new investment that channels into CapEx - I don't have a clue how successful that investment is going to be.
I realize my 2 company example is likely far too simple to apply directly to a real world perspective, but the purpose of this post is to try to convey that from an earnings per share (or dividends per share) perspective, reductions in the amount of total outstanding shares can be very effective. The ideal scenario is to find a company that can grow the numerator AND shrink the denominator simultaneously. But by focusing solely on the numerator, you might be missing out.
Here is a list of strong-branded, stable, proven companies that have wonderful buyback programs in place (I just so happen to be long all of these comanies).
XOM, IBM, GPS, COH, TGT, BLL, DPS