Most companies distribute a portion of their earnings to their shareholders in the form of dividends. However, there is a minority that prefers share repurchases to dividends. Warren Buffett has mentioned that he is a fan of share repurchases for various reasons as long as they are carried out at prices below the intrinsic value of the company.
First of all, share buybacks prove that the company perceives value in its shares at the prevailing market price, which is encouraging for investors as the managers know the company much better than the investors. Moreover, Buffet is interested in companies with share repurchases because he thus increases his stake in the company without spending a single penny. Another reason Buffett is fond of share buybacks is that this type of distribution is tax-free, as opposed to the dividend. I will add just one more reason, which may be the most important. If a company purchases its shares at a high rate for many years, these purchases become increasingly effective over time in raising its EPS (please read below the case of Torchmark).
In this article, I will mention a few premium companies that perform share repurchases at an aggressive rate.
Exxon Mobil (XOM)
Exxon Mobil is the company with the largest market cap besides Apple (AAPL). In the last 9 years, Exxon has doubled its earnings. Moreover, it has purchased almost 1/3 of its shares and hence it has tripled its EPS. This is exceptional EPS growth, which outperforms that of other premium companies, such as Coca-Cola (KO), Wal-Mart (WMT) and Procter & Gamble (PG), largely thanks to the share buyback program of Exxon.
While the company is often overlooked for its low dividend yield (2.5%), which is lower than that of most oil companies, it purchases about $20 B of its shares every year. As its market cap is approximately $400 B, the share repurchases are equivalent to an additional 5% return to its shareholders.
Exxon has achieved the above exceptional performance while it has kept its net debt at a minimum level, equal to just three years' earnings. Therefore, it can easily maintain its current share buyback program in the future.
International Business Machines (IBM)
Warren Buffett is infamous for avoiding the tech stocks due to the highly-competitive nature of the sector and consequently the lack of predictability of future earnings. However, he eventually made an exception and purchased a 6% stake in IBM in 2011.
IBM has increased its earnings 150% in the last nine years and has reduced its float by 1/3 and hence the company has managed to almost quadruple its EPS. IBM has easily maintained a low amount of net debt, which is less than four years' earnings. Therefore, it is expected to easily sustain its share buyback program in the future.
Target Corporation (TGT)
Target Corporation operates 1778 general merchandise stores in the U.S. and offers credit to its customers through its proprietary credit cards. In the last nine years, the company has doubled its earnings. Moreover, it has reduced its float by 27%, from 912 M to 662 M, and hence it has increased its EPS by 160%. In January 2012, the company authorized a new share buyback program of $5 B. At the current stock price of $64 the program will reduce the number of outstanding shares by 12%.
The net debt of Target is relatively higher than that of Exxon and IBM, as it stands at about nine times its annual earnings. However, given its average annual 11% growth of EPS in the last decade, the company seems capable of sustaining its share buyback program.
Torchmark is an insurance company that has grown consistently over its 32-year lifetime. As per the available data for the period 1995-2012, Torchmark has demonstrated an almost linear, consistent growth of earnings per share.
In the last 10 years, Torchmark has increased its earnings only 38%. However, during this period, the company has reduced its outstanding shares by 46%, from 177.4 M to 95.1 M , which has resulted in EPS growth 157%.
If the company continues to purchase about 8 M shares per year, which is possible thanks to its earnings, then the outstanding shares in 10 years will be only 1/6 of the current number, which will raise the EPS (and subsequently the stock price) by 6 times. This verifies what was mentioned in the introduction of the article; the lower the number of outstanding shares the greater the effect of share repurchases on the EPS growth. More details about Torchmark can be found in this article.
Autozone is the U.S. leading retailer and a leading distributor of automotive parts and accessories. The company is active in the U.S. and Mexico and is considering expanding in Brazil.
Autozone has less than doubled its earnings in the last nine years. However, it has reduced its float by 58%, from 88.7 M to 37.0 M, and hence it has more than quadrupled its EPS during this period. The company renews its share buyback program of $750 M every year. If it continues, it will be purchasing about 2 M shares every year at the current stock price.
What is really impressive is that the company continued purchasing its shares relentlessly, without preserving any cash, during the great recession of 2008. This is the opposite of what almost all companies did (including the ones mentioned above) but the self-confidence paid out as the company was able to purchase more shares at a great bargain price during the recession.
This extreme self-confidence might worry some of its investors as the company keeps increasing its debt in order to buy its shares and has reached a negative book value $1.5 B! As the current assets are $3 B and the current liabilities are $3.7 B, the company will almost need the whole year's profit in order to pay all its current liabilities. This proves that the company has stretched its confidence to the limits and may be susceptible to an unforeseen headwind.
I have included Apple in this article only as the great absent, as it does not repurchase its shares. Apple has become a legend for its outstanding innovations, which led the stock price from $7 to $700 in exactly 10 years (September 2002 - September 2012) while its earnings multiplied by about 500 times. It has accumulated a cash hoard of about $137 B, which is likely to grow to about $200 B in two years from now. The optimal use of this cash hoard has raised great controversy among shareholders and analysts.
In my opinion, Apple should not waste this unprecedented amount of cash in dividends, which will be subtracted from the value of the company. Moreover, it is impressive that the stock of Apple trades at a very low P/E (10). Therefore, the most efficient use of the cash to protect the shareholders is in share repurchases. Apple can gradually use this $200 B to purchase approximately half of its shares at levels close to the current market price. In this way, Apple will permanently double its EPS and greatly protect its stock price.
Just as the central bank of Switzerland declares that it will not let the euro fall below 1.20 Francs (by selling Francs), in the same way Apple can declare that it will not allow its stock price fall below $400 by purchasing all the shares available at levels below $400. Therefore, Apple can significantly restrict the rate of decline of its stock price in the near future. So far the management has not shown any interest in share repurchases but this may change soon…
To make the most profitable investments, an investor should select the stocks that will achieve the highest EPS growth, not the highest earnings growth, as the former is the driver for stock price appreciation. Share repurchases can greatly enhance the EPS growth, even of companies with average growth. Nevertheless, an investor should carefully assess whether a company can sustain its share buyback program before investing in it.