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The intent of this case study is to determine if there is a predictable profitable pattern when a company consistently purchases stock and increases dividends. The motivation behind the article was Intel Corp.'s (NASDAQ:INTC) recent announcement of a debt offering to buy back shares. By conducting the study, I am hoping to gain insight into whether buybacks have a positive impact on shareholder wealth, or if they are a short-term strategy that causes the stock to jump.

The three candidates used are all current Dow 30 members, and are large, well-established companies with predictable earnings potential. The intent of this study is to compound gains over a long period of time. The strategy is not suitable for short-term investments (less than two year trading horizons), but will generate substantial gains over time. The period used in the study was 1996 through 2011, which encompassed a roaring bull market and two subsequent busts.

McDonald's Corp (NYSE:MCD)

1996

1997

1998

1999

2000

2001

2002

2003

1,389 shares outstanding in millions

1,371

1,356

1,350

1,304

1,280

1,268

1,261

0.15

Dividends

Per share

0.16

0.18

0.2

0.22

0.23

0.24

0.4

1.11

Earnings per share

1.15

1.26

1.39

1.46

1.36

1.32

1.43

2004

2005

2006

2007

2008

2009

2010

2011

1,269

Shares outstanding in millions

1,263

1,203

1,165

1,115

1,076

1,053

1,021

0.55

Dividends per share

0.67

1.00

1.5

1.63

2.05

2.26

2.53

1.93

Earnings per share

1.97

2.3

2.91

3.67

3.98

4.6

5.27

The first candidate is McDonalds corp. (MCD). MCD is the world's largest restaurant chain with over 34,000 restaurants. The table above shows MCD outstanding shares, dividend rate and earnings for the period of 1996 through 2011. I will be using closing prices on January 2, 1996 as the purchase price for the four candidates of this study. MCD closed at a split and dividend adjusted 16.65 per share on January 2, 1996. Share count from 1996 has shrunk by over 25% in the study period, while earnings have more than tripled.

Patience and perseverance are the hallmark of this strategy. In 2003, MCD hit a significant rough patch, and the shares were trading back to where they stood in 1996. In essence, the stock languished for eight years with a zero return. Warren Buffett has been quoted as saying that when we begin to build a position in a company, we don't mind if the shares languish for a while. By languishing, it allowed the company to repurchase more shares at a reduced rate, making the outstanding shares worth a higher percentage of future profits.

MCD managed to correct what ailed it and future profits greatly accelerated from there, along with the share price. The patient investor who held from 1996 and sold on December 30, 2011 (the last trading day of the study) would have a gain of over $80 per share, which works out to a gain of over 4x your money.

Intel Corp (INTC)

1996

1997

1998

1999

2000

2001

2002

2003

6,568

Shares outstanding in millions

6,512

6,630

6,668

6,721

6,690

6,570

6,487

0.02

Dividends per share

0.03

0.03

0.05

0.07

0.08

0.08

0.08

0.73

Earnings per share

0.97

0.89

1.17

1.53

0.53

0.51

0.86

2004

2005

2006

2007

2008

2009

2010

2011

6,253

Shares outstanding

5,919

5,766

5,818

5,562

5,523

5,511

5,581

0.16

Dividends per share

0.32

0.41

0.45

0.55

0.56

0.63

0.78

1.16

Earnings per share

1.40

0.86

1.18

0.92

0.77

2.05

2.39

The second candidate for the study is Intel Corp., the world's leading manufacturer of semiconductors. As we can see from the table above, INTC has retired just short of 1 billion shares while managing to more than triple its earnings. INTC was trading at an adjusted price of $5.78 at the start of the study, with a closing price of $23.44, which works out to a roughly fourfold gain. From an income perspective, the original shares now yield over 13%, which is fantastic. This is a great example of the power of compounding dividends coupled with consistent raises over the years.

INTC Chart

INTC data by YCharts

INTC differs from MCD when we look at earnings over the course of the period. INTC's profits aren't as consistent; instead, they exhibit a more cyclical nature. In my opinion, INTC is entering one of its down cycles, which could become a very attractive entry. As we can see from the chart above, the stock has significantly underperformed the market, as INTC was forced to lower guidance for last quarter as well as the upcoming quarter.

The most interesting announcement was the company borrowing at some very attractive rates to fund additional share repurchases. $3 billion was borrowed at a rate of 1.35%, due in 2017, and an additional $1.5 billion at 2.7%, due in 2022. The rate of interest on the debt is currently less than what the ordinary shares yield, so an immediate buyback of $4.5 billion shares would shrink the shares outstanding by a little over 4% (104 billion market cap divided by 4.5 billion).

The more aggressive buyback, when coupled with INTC's consistent quarterly buybacks, will significantly shrink the shares outstanding going forward. When INTC's business experiences a cyclical upswing, the earnings per share growth will be positively impacted by the buybacks, handsomely rewarding patient shareholders. INTC's new product cycle, along with its wide moat led me to initially invest, as written about here.

International Business Machines (NYSE:IBM)

1996

1997

1998

1999

2000

2001

2002

2003

2,032 shares outstanding in millions

1,937

1,852

1,804

1,763

1,723

1,722

1,695

0.33 dividends per share

0.39

0.44

0.47

0.51

0.55

0.59

0.63

2.76 earnings per share

3.01

3.29

3.72

4.44

4.35

3.95

4.34

2004

2005

2006

2007

2008

2009

2010

2011

1,645 shares outstanding in millions

1,574

1,507

1,385

1,339

1,305

1,228

1,163

0.70

dividends per share

0.78

1.1

1.5

1.9

2.15

2.5

2.9

5.05 earnings per share

5.22

6.01

7.18

8.93

10.01

11.52

13.06

The third candidate is IBM, which in my opinion, offers the best example of the effectiveness of this strategy. IBM began the study period at $18.83 per share and ended it at $180.84, which is an almost tenfold increase from the original investment. The company has managed to buy back a little less than half of its remaining shares while significantly raising the dividend. The stellar performance provided by IBM has recently caught Warren Buffett's attention, as he has amassed a large stake in the company.

The investment cases for IBM can be summed up best with expect more of the same. The company will continue to aggressively buy back shares and slowly increase dividends. I have written more extensively about IBM here. I am very comfortable holding it here, and will look to add to my position upon any dip below my original entry price.

In summary, aggressive consistent buybacks can have a tremendously profitable effect on a company's bottom line, along with shareholder gains. I currently own INTC and IBM, and am comfortable holding them for the long haul. I expect them to continue to aggressively buy back shares and raise their dividends. I will look to reenter into a position in MCD at a lower level. I am still unconvinced that consumer spending will rebound sharply, and anticipate being able to pick up the shares at lower levels at some point next year.

Source: How Increasing Dividends And Stock Buybacks Leads To Long-Term Capital Gains

Additional disclosure: The article is for informational purposes only and is not actual investment advice.