I'm a bit skeptical about companies undertaking massive share buyback programs.
What if the company is buying back its own shares above their intrinsic value?
Furthermore, the funds used for share buybacks could be invested in growth opportunities, research and development, or other financial activities. By opting for buybacks, the company may miss out on potential future growth with a higher return on invested capital (ROIC).
The answer to both is making sure a company has good management.
Management's main job is capital allocation.
Buybacks above intrinsic value destroy capital.
Buybacks at the expense of strengthening the company or investing in a good growth opportunity aren't the best use of capital either. Companies that can re-invest all of the profit into high ROIC projects are rare. When you hit the point of diminishing returns, the question becomes what to do with the profit that's left. Sometimes buybacks are a good answer, sometimes they aren't.
Fortunately, management of companies that complete heavy buybacks seem to get it right on average.
Michael Mauboussin wrote a paper about it in July. You can read it here:
The most important conclusion: "We find that companies with low SBC issuance and high buybacks delivered the highest average and median TSRs of the groups. Firms with high SBC and low buybacks produced the lowest returns."
I do not disagree. Good points. I always read the proxy statement of companies as it indicates how management is compensated. If you find one that indicates ROIC, then it is worth taking a hard look.
How we value buybacks depends on our investment goals.
If you are looking to grow your portfolio value, especially in your working years, then buybacks done right can seriously supercharge your gains! You started to illustrate the idea with the pizzas and the chart before it referencing the shares bought back vs the return. Now take this to an extreme level. 😯
Imagine you own 1 share of a company. Literally - 1 share. That's it. This share is your prized possession 🥰 and you hug it like your favorite teddy bear. 🧸
You are one out of thousands and thousands of shareholders. Now start imaging the company buying up 50% of its outstanding shares. These shares are taken off the market and torn up. That's the same as if none of the shares were purchased by the company but you owned 2 shares, assuming nothing in the company changed (revenue, profits, etc). You just doubled your value. ⭐
Now imagine this is done over and over and over again. Each time this happens there are less and less shareholders. Your ownership stake keeps increasing over and over and over again. A share that was worth $1 in the beginning could go to $2 and then $4 and then $8 and then ... 🎢
Now comes the extreme part. Imagine after all those share buybacks you are the last shareholder. 😯 The last single share of the company possibly available is in your hands. Despite all the offers and chance to sell that one share, you held on to it with all of your mind, body, and soul. You own the company now! 🥳 It's yours! If the company is worth $100M or $1B or whatever then that single share is probably worth that $100M or $1B. 🤑 Obviously the market's forces of supply and demand come into play. You may own the last share that nobody wants. But, what if it was the last share of AutoZone, Ameriprise, or Apple? 🤔
(I don't know why I got stuck on the letter A?)
By golly, those share buybacks can make you paper-rich! 💰
That's extreme case of value being added with share buybacks. Is there an example of share buybacks done wrong? Absolutely! Look up the company Big Lots. Plot the total outstanding share count over the past 10 years and overlay the share price on top of it. You will see the retailer retired approximately 10 million shares between the Q2 2020 and Q1 2022 when the stock price was at a 10 year peak!! 🤯 Talk about poor capital allocation! The stock price is about $0.10 and the company is preparing for bankruptcy. 😭 And remember, there's always someone out there who bought the last share at the absolute highest price before the whole thing started to collapse.
I think the lesson here is that buybacks done right can add a lot of shareholder value and done wrong they can be absolutely disastrous. Buybacks are just one way a company can create shareholder value. A company can buy back shares, issue a dividend, pay down debts, reinvest in itself, and acquire companies at the same time. Google is a prime example. That company has SO.MUCH.CASH. that they don't know what to do with it all. Before they did not pay a dividend and now they do. They also bought back about 1 billion shares since 2019.
Now, if all you want is an income stream while retaining your share count then this isn't it for you. Get some Coca-Cola stock and soda and enjoy both. 😉
I think buybacks done in the "overvalued" situation you're talking about are frequently done not with the goal to return capital to shareholders, but instead to offset stock-based comp for management. No argument from me that it's a good use of capital, but I think that's how the management teams and boards justify it to themselves.
No capital allocation choice is always good or bad. It always depends on the situation, opportunity costs, etc.
Your sense is correct but also a serious view. Wall street rewards stock buybacks, often at any price and even, in some cases, stock splits. If you are a ceo, what would you do? Do an accelerated share repurchase at high prices or reinvest in the company's business and perhaps wait years for a return?
This is why having good management in place is so important. The best we can do is look at their past capital allocation record, and how the incentive structure is set up to make an educated guess on what they'll do in the future.
I'm a bit skeptical about companies undertaking massive share buyback programs.
What if the company is buying back its own shares above their intrinsic value?
Furthermore, the funds used for share buybacks could be invested in growth opportunities, research and development, or other financial activities. By opting for buybacks, the company may miss out on potential future growth with a higher return on invested capital (ROIC).
Those are both legitimate concerns.
The answer to both is making sure a company has good management.
Management's main job is capital allocation.
Buybacks above intrinsic value destroy capital.
Buybacks at the expense of strengthening the company or investing in a good growth opportunity aren't the best use of capital either. Companies that can re-invest all of the profit into high ROIC projects are rare. When you hit the point of diminishing returns, the question becomes what to do with the profit that's left. Sometimes buybacks are a good answer, sometimes they aren't.
Fortunately, management of companies that complete heavy buybacks seem to get it right on average.
Michael Mauboussin wrote a paper about it in July. You can read it here:
https://www.morganstanley.com/im/en-us/individual-investor/insights/articles/which-one-is-it-equity-issuance-retirement.html
The most important conclusion: "We find that companies with low SBC issuance and high buybacks delivered the highest average and median TSRs of the groups. Firms with high SBC and low buybacks produced the lowest returns."
I do not disagree. Good points. I always read the proxy statement of companies as it indicates how management is compensated. If you find one that indicates ROIC, then it is worth taking a hard look.
How we value buybacks depends on our investment goals.
If you are looking to grow your portfolio value, especially in your working years, then buybacks done right can seriously supercharge your gains! You started to illustrate the idea with the pizzas and the chart before it referencing the shares bought back vs the return. Now take this to an extreme level. 😯
Imagine you own 1 share of a company. Literally - 1 share. That's it. This share is your prized possession 🥰 and you hug it like your favorite teddy bear. 🧸
You are one out of thousands and thousands of shareholders. Now start imaging the company buying up 50% of its outstanding shares. These shares are taken off the market and torn up. That's the same as if none of the shares were purchased by the company but you owned 2 shares, assuming nothing in the company changed (revenue, profits, etc). You just doubled your value. ⭐
Now imagine this is done over and over and over again. Each time this happens there are less and less shareholders. Your ownership stake keeps increasing over and over and over again. A share that was worth $1 in the beginning could go to $2 and then $4 and then $8 and then ... 🎢
Now comes the extreme part. Imagine after all those share buybacks you are the last shareholder. 😯 The last single share of the company possibly available is in your hands. Despite all the offers and chance to sell that one share, you held on to it with all of your mind, body, and soul. You own the company now! 🥳 It's yours! If the company is worth $100M or $1B or whatever then that single share is probably worth that $100M or $1B. 🤑 Obviously the market's forces of supply and demand come into play. You may own the last share that nobody wants. But, what if it was the last share of AutoZone, Ameriprise, or Apple? 🤔
(I don't know why I got stuck on the letter A?)
By golly, those share buybacks can make you paper-rich! 💰
That's extreme case of value being added with share buybacks. Is there an example of share buybacks done wrong? Absolutely! Look up the company Big Lots. Plot the total outstanding share count over the past 10 years and overlay the share price on top of it. You will see the retailer retired approximately 10 million shares between the Q2 2020 and Q1 2022 when the stock price was at a 10 year peak!! 🤯 Talk about poor capital allocation! The stock price is about $0.10 and the company is preparing for bankruptcy. 😭 And remember, there's always someone out there who bought the last share at the absolute highest price before the whole thing started to collapse.
I think the lesson here is that buybacks done right can add a lot of shareholder value and done wrong they can be absolutely disastrous. Buybacks are just one way a company can create shareholder value. A company can buy back shares, issue a dividend, pay down debts, reinvest in itself, and acquire companies at the same time. Google is a prime example. That company has SO.MUCH.CASH. that they don't know what to do with it all. Before they did not pay a dividend and now they do. They also bought back about 1 billion shares since 2019.
Now, if all you want is an income stream while retaining your share count then this isn't it for you. Get some Coca-Cola stock and soda and enjoy both. 😉
They are especially beneficial when companies' shares are trading at record highs and likely "over-valued" when a large number of buybacks occur.
I sense sarcasm 😀
If you haven't read it yet, you'd likely be interested in the Mauboussin paper I linked in response to Miguel's comment as well.
https://www.morganstanley.com/im/en-us/individual-investor/insights/articles/which-one-is-it-equity-issuance-retirement.html
I think buybacks done in the "overvalued" situation you're talking about are frequently done not with the goal to return capital to shareholders, but instead to offset stock-based comp for management. No argument from me that it's a good use of capital, but I think that's how the management teams and boards justify it to themselves.
No capital allocation choice is always good or bad. It always depends on the situation, opportunity costs, etc.
Your sense is correct but also a serious view. Wall street rewards stock buybacks, often at any price and even, in some cases, stock splits. If you are a ceo, what would you do? Do an accelerated share repurchase at high prices or reinvest in the company's business and perhaps wait years for a return?
This is why having good management in place is so important. The best we can do is look at their past capital allocation record, and how the incentive structure is set up to make an educated guess on what they'll do in the future.