In the fourth quarter of 2012, Exxon Mobil (NYSE:XOM) spent $5 billion buying back shares. This is a typical quarterly experience for the company (the firm has bought back and retired shares in every quarter dating back to at least 2002), and is a big component of the company's growth strategy. After all, when you are a $400 billion company earning $40-$50 billion per year, it is hard to find a lot of attractive opportunities that will grow the business organically. As Charles Sitter, the former President of Exxon, once said: "shareholders, like creditors, have given the company only the temporary use of their funds. If the available opportunities are not sufficiently attractive, the company should have no greater compunction about returning money to shareholders -paying dividends or buying back stock-than it would have about prepaying debt. The trick is to not be 'macho' about building a large cash kitty and then stretching to find uses for it."
Because of Exxon's current size, this means that the company chooses to run an automatic buyback program that reduces the share count every quarter to drive earnings growth and facilitate dividend growth. For shareholders, this has been a value-creating experience because Exxon stock does not usually get terribly overvalued (its P/E ratio has only been above 12 one year since 2004), and this is good news for long-term shareholders considering that Exxon is always buying back shares.
Of course, there is a flip side to this as well: it also means that Exxon shareholders will not enjoy the benefit of only having shares retired at an opportune time (compared to say, something like the Berkshire Hathaway policy of only retiring shares when the stock price falls below a conservative estimate of intrinsic value, defined as 120% of book value). When we look at Exxon's record from 2004-2011, we can see that Exxon bought back 2.55 billion shares, paying $180 billion to do so. As of last year, Credit Suisse estimates that the Exxon stock buyback creates about 5% of value annually for shareholders (on a relative basis, this is nothing to sneeze at considering that over a third of stock buybacks among S&P 500 members actually destroy shareholder value).
As an Exxon shareholder, I do have one concern about the execution of the company's buyback program: when oil prices are increasing (and thus, profits and share prices are peaking), the company increases its stock buyback because it has a larger amount of cash on hand. However, when the price of oil falls (and thus, profits are lower and share prices tend to be lower), the company scales back its buyback program.
Let's look at the company's buyback performance during the years 2007, 2008 and 2009 to underscore the point.
In 2007 and 2008, things were going great for Exxon. The earnings per share had increased from $6.55 per share at the start of 2007 to $8.69 by the end of 2008. The stock price hit highs in the $90s. With all these record-smashing profits, the company bought back about $7.5 billion in stock each quarter in 2007, and raised that to $8-$9 billion in 2008. These two years represent Exxon Mobil's largest commitment to its buyback program to date.
Fast forward a year to 2009. The earnings per share fell to $3.98. The stock price fell to the low $60s. Because profits were down, Exxon had to scale its buyback program down from $5 billion at the start of 2009 to $4 billion in the middle of 2009, and then the company only bought back $2 billion worth of shares in the final quarter of 2009. When earnings and share prices were at the highest, Exxon was setting aside 3x as much money for stock buybacks as when earnings and buybacks were at their lowest in 2009.
This is no special indictment of Exxon, but rather, an example of a difficulty with stock buybacks in general. When a company has record profits that create excess beyond reinvestment needs, it is easier to find money to increase a stock buyback program. Unfortunately, this is also when stock prices are likely to be higher. The same problem shapes the other side: when profits are falling, buyback programs are often scaled back, and unfortunately, this is often when stock prices are trading low. This is the important caveat to keep in mind, based on Exxon's recent history.
The good news, of course, is that even through this period, Exxon's buyback program managed to create value for shareholders. That is certainly a plus. And a constant buyback is likely a necessary way to drive earnings growth for a company of Exxon's size, because there are only so many capital expenditures that a company can find when dealing with $40-$50 billion in annual earnings. But Exxon also has a tendency to increase buybacks at a time when prices are likely to be higher, and decrease them at a time when prices are likely to be lower. Fortunately, Exxon's buyback has managed to create value in spite of this fact.