Esteemed Seeking Alpha contributor Macro Investor recently penned a well-reasoned piece wherein he posited that stock buybacks are nothing but a "gimmick" that corporate managements use to show the world that they think their company's stock is undervalued, using Intel (INTC) as an example. He points out that the enterprise value of the company doesn't change, and on this point, he is absolutely correct. However, the enterprise value of Intel is essentially pointless. This article will take a brief look at why share buybacks are important, how they can be used to boost share prices and why I will respectfully disagree with the author, believing the enterprise value argument is misguided.
Enterprise value is, in fact, an important piece of a company's valuation. It describes what an acquiring company would have to pay in order to purchase the target. However, as there is no company on the planet large enough to swallow Intel, I'm not certain how its enterprise value is relevant to anything. The author points out, correctly, that the enterprise value of the company does not change when equity is exchanged for debt, as is the case with Intel. For those of you who missed it, Intel recently offered $6B in debt that will be used to buy back shares. Macro Investor correctly points out that this type of exchange does nothing to change the value of the company but what he is missing is that this point is only relevant for an acquiring entity. The acquirer wouldn't have to pay a different price for Intel after the debt offering than before, assuming management did spend the entire sum on buying back shares. However, for individual investors, this is a significant event. Although the value of the company hasn't changed, the equity portion is contracted because there is now an additional $6B of debt financing the company is using and $6B less in shares outstanding.
What this means is that for every share of stock that remains after the buyback, a larger piece of the equity of the company is attributable to it. In essence, for every dollar the company earns after the buyback, a larger portion of the earnings are attributable to each share than before the buyback, which should result in a higher stock price, all else equal. This is how buybacks are bullish for equity owners and this is why the enterprise value argument is, in my view, imprudent.
Intel's Buyback History
Now that we have that sorted out, let's examine Intel's buybacks since 2000. I pulled all of the 10-Ks and 10-Qs that were available on the SEC's website and pulled the number of outstanding shares from each. After pulling the data, I produced the graphs below.
First, let's take a look at Intel's outstanding share count since the end of 2000. Intel has been aggressively buying back stock on and off for the last decade and the results can be seen here:
Essentially, what this shows is that Intel has reduced its share count from 6.718B shares outstanding at the end of 2000 to 4.976B at the end of this year's third quarter. This enormous reduction in outstanding shares is quite bullish and proves that Intel's management is extremely shareholder friendly. Now, I'm not sure what my colleague thinks about this graph but I would love it if all the companies I own stock in had management like Intel. We'll have more on this a bit later.
Another benefit of Intel's buyback program is that it is partially paid for by the dividends the company no longer has to pay on the shares it buys back from investors. This point was made by Macro Investor in his article and he is absolutely correct. However, I wanted to try and get a quantifiable estimate of just how much the buyback program at Intel has benefited the company, and by extension, investors, so I used the outstanding share count data I composed and then collected Intel's dividend history. This graph basically shows an estimate of how much money Intel has saved on dividends over the past decade or so because of the buyback:
Please understand, there is absolutely no way in the world anybody could pin down the exact amount of money Intel has saved via the buyback through decreased dividends payable. However, my method was to use the outstanding share counts from the Qs and Ks and the dividend history provided by Intel to figure out how much the company paid in dividends during each period and how much it would have paid if the buyback program did not exist. In other words, this graph shows what would have been paid if Intel had never purchased a single share starting at the end of 2000 minus what it actually paid after the share repurchases. The "savings" are the line above. As you can see, after Intel started to aggressively increase its dividend in the early 2000s, the dividend savings from the decreased share count started to ramp. Essentially, by my estimation, Intel has saved roughly $1.5B since 2000 simply through decreased dividends payable as a direct result of the buyback program.
Earnings Multiples and Valuations
The last point I'd like to discuss is that of earnings multiples in relation to share counts and share prices. We all know that one of the fundamental valuation tools that is used by investors is the price-to-earnings multiple. Below is a graph of Intel's trailing 12 month PE ratio, courtesy of YCharts:
So, for the sake of argument, let's use today's TTM PE ratio of 8.834 for our example. Below is a table I constructed that shows Intel's EPS and price estimations with and without the buyback that has occurred since the end of 2000. I realize these prices are subject to change and I'm not predicting what Intel shares will trade for, but the basic point stands. It is quite easy to see what Intel shares might look like today if no buyback had occurred.
Net Income ($B)
EPS W/O Buyback
Price W/O Buyback
This table shows that, with the net income numbers above, which were pulled from Yahoo! Finance analyst compilations, Intel's 2012 EPS number is expected to be $2.11. However, by my calculations, if no buyback had occurred since the end of 2000, that same $10.5B in net income would result in only $1.56 per share in earnings. Given the 8.834 PE ratio, we could reasonably expect Intel shares would be trading for less than $14. The same methodology was applied to 2013 estimates and you can see that the difference in share price is drastic, as the "non-buyback" number is approximately 26% below the estimate for the "buyback" number.
Again, the focus here is not on the actual share prices but the magnitude with which they differ. The fact is that share buybacks can be great at boosting, or at least supporting, the price of a company's shares. Macro Investor points out that Intel's shares have "floundered" while the buyback has occurred, and he is right, but I've shown how much worse the fall could have been without the buyback. Had Intel not bought back shares, it could be trading for $13 or $14 currently instead of $20.
I'm not suggesting that stock buybacks are a panacea for a company's ills or that a sizable buyback is a reason to get into a stock, but what I am suggesting is that when someone tells you "smart" investors should ignore buybacks, you should instead take a closer look. We have shown here that buybacks can be effective and writing them off as a "gimmick" is short-sighted and can cost you a potentially great investment.