Any time financial media outlets get caught up in the minutia of quarterly results and speculation about whether a certain stock will beat the S&P 500 over the next three months, six months, or whatever, I usually like to step back and ask the question, "Does any of the news today actually mean anything for long-term shareholders?"
In the case of Wal-Mart (WMT), the main newsworthy item that has come out this summer is the company's plan to repurchase $15 billion worth of its stock. Wal-Mart has above-average credibility when it comes to reducing share count - it runs the 8th largest stock buyback program in the world, and there have only been six quarters since 2004 when the company did not retire any stock at all. According to Credit Suisse, Wal-Mart has achieved an annual return of 8.9% on its repurchased stock since 2004.
Most importantly, Wal-Mart's buyback program has been a useful way to stimulate earnings per share growth as the company has morphed into a $250 billion enterprise over the past decade.
Let's take a look at what Wal-Mart's buyback program has been able to accomplish for shareholders since 2006.
In 2006, Wal-Mart was a company split up into 4.131 billion pieces that earned $12.17 billion in net profit. In 2012, thanks to Wal-Mart's buyback program, the company was split into only 3.31 billion pieces that earned $16.99 billion in net profit. Earnings per share increased from $2.92 per share in 2006 to $5.02 in 2012.
In terms of the entire company, profits grew by almost 40% from 2006 through 2012. But because Wal-Mart's share buyback program kicked out one out of every five shareholding units from the picture in exchange for cash, that 40% growth in profits got spread out amongst a smaller base so that shareholders actually experienced 72% growth in earnings per share since 2006.
This gave Wal-Mart the flexibility to increase its dividend by 237% during the 2006 to 2012 time frame because the long-term shareholders experienced three factors mixing together to work in their favor: the business itself was growing and producing more profits, the share count was declining so that the dividend payments could be increased easier due to a small share count base to appease, and the company had been simultaneously increasing its dividend payout ratio to shareholders so that the dividend growth rate could outstrip the earnings per share growth rate (while this bonus is ultimately an unsustainable practice over the truly long term, it can be a fun gravy train to ride for ten to fifteen years).
But when you look at what Wal-Mart did over the past 6+ years, you can see that the spirit of its corporate governance policy is something that applies to other blue-chip stocks as well (the ones I have in mind are IBM (IBM), Microsoft (MSFT), and ExxonMobil (XOM)). Sometimes, companies grow so large that it becomes unrealistic to grow earnings per share organically by 10% over the long term.
But an intelligently conceived buyback program can add a nice kick to the long-term earnings per share growth rate for the megacap cash cows in the dividend investing universe. We've all heard at some point or other that IBM, Exxon, and Microsoft have gotten too big to grow. More precisely though, what those pundits are saying is that those companies have gotten too big to grow at rates in line with past performance.
In the case of Microsoft, IBM, and Exxon, it is not unrealistic to see total profits grow by 5-6% annually but the company actually manages to grow earnings per share by that magical 10% figure due to a lower share count that bridges the gap. As long as the shares are actually retired and repurchased at a sensible price, the avenue exists for these companies to deliver future returns somewhat in line with past glories.
Wal-Mart is a real live case study that shows us what that path looks like. The company itself may have only grown by 40%, but your ownership stake's operational results actually increased by 72%. If Wal-Mart ever decided to pay out all those profits as dividends, that money would spend just the same whether it was fueled by organic growth or the stimulation provided by a buyback program. As a long-term shareholder in some megacap companies, I keep a close eye on the efficiency of the buyback program. As long as the $15 billion buyback announcements keep coming, the satisfactory dividend and earnings per share growth can continue even if the company's business performance itself becomes more lumbering than in decades past.