- IBM has spent over $45 billion on stock buybacks in the last 12 quarters.
- In addition to cutting back the outstanding shares, the company has avoided paying dividends of over $1.2 billion over that time.
- I will discuss how good (or bad) the return on investment has been for the buybacks.
When a company buys back its own stock, we often like to write about how great that is -- or, how bad that is, depending on the opinion of the writer. What we don't often see is a quantitative analysis of what the return for the company actually was for past buybacks.
It is important to calculate the Buyback ROI (return on investment). If a company could use cash to expand the business at a rate of x and the buyback return computes to a rate of y, then, as a shareholder, you want to see y > x. That is obviously a bit of oversimplification. There are other factors for company management to consider when it comes to buybacks. However, a solid rate of return compared to other options should be very high on the priority list.
When a company buys back stock and the price rises, that is good! It will achieve a positive Buyback ROI. When the stock goes lower than the buyback price, that is bad! The company's Buyback ROI will normally be negative in that case. Note that saved dividend payouts can push the Buyback ROI into positive territory, even if the stock goes lower from the buyback point.
I won't go into the nitty-gritties of the math behind all the calculations. For those that wish to know how I attained the figures below, I highly recommend this article that explains it quite well. I will summarize the calculations, which should be sufficient for those readers with an understanding of the principles.
IBM's Recent Buybacks
International Business Machines (NYSE:IBM) has been very aggressive in buybacks over the last 12 quarters (and beyond). Here is a graph of the outstanding shares:
IBM spent about $45.34 billion over the last 12 quarters on stock, and the value of those shares as of Q2 2014 was about $44.75 billion. That equates to a total loss of about 1.3%, but does not tell us the annualized gain of either the shares themselves nor the $1.2 billion in dividend payouts saved during that time. To get a figure that is meaningful, we need to do the slightly painful calculation of the Buyback ROI.
Looking at the last 12 quarters reveals the following history:
|Time Period||Shares Bought||Avg. Price of Purchase|
(Source: IBM 10-Q and 10-K filings)
The following steps are taken to determine the Buyback ROI:
- For each quarter, multiply the shares bought by the avg. price = amount spent.
- Multiply the cumulative shares bought by the dividend paid that quarter = dividend payout saved.
- Add the dividend payout saved to the amount spent = cash inflow (or outflow) for the quarter.
- Repeat steps 1-3 for the 6-quarter analysis.
- For the last quarter, multiply the cumulative shares purchased by the final quarter share price, and add that number into the cash inflow (or outflow) for the quarter. This is the final value of all the shares the company purchased.
- Finally, all of the 12 calculated cash inflows (or outflows) are run through an internal rate of return calculation to produce the Buyback ROI figure.
For IBM, in the last 12 quarters, the Buyback ROI was a paltry 1.3%.
By comparing the Buyback ROI to the "Buyback Strategy" and to the "Buyback Effectiveness", we can how well the company picked the exact timing of the buybacks it made. The article that I linked above uses those two terms to mean the following:
- Buyback Strategy: The CAGR of the total return of the stock during the time of the analysis. This can be thought of as the "baseline" ROI number that the buyback would have achieved if the stock had no peaks or valleys. In other words, if the stock simply moved in a straight line, this would be identical to the Buyback ROI.
- Buyback Effectiveness: A comparison of the actual Buyback ROI to the Buyback Strategy: (1 + Buyback ROI) / (1 + Buyback Strategy) - 1. If a company has a positive Buyback Effectiveness, then it did a good job buying on the dips and avoiding the peaks. Think of this number as a scorecard measuring the short-term trading ability of the company.
Our final figures are as follows:
Buyback ROI: 1.3%
Buyback Strategy: 5.7%
Buyback Effectiveness: -4.2%
There are many other factors of buybacks to consider whenever evaluating any company. Does the company use a lot of stock options to pay employees? Are the buybacks used as a desperate measure to bump up EPS for a business that has slow growth? The list of pros and cons for buybacks is long and eminently debatable. Those are important, but are beyond the scope of this article.
The main priority of a company buyback should be to get a return on investment that is better than other options for the funds. Buying back stock when it is undervalued is an excellent use of cash (or even low-cost debt, up to a point). However, IBM has only achieved a Buyback ROI of 1.3% as of Q1 2014. And, in fact, as of today the stock is down about 2% from that point which lowers the Buyback ROI even further.
To add insult to injury, the company has timed its purchases poorly and should have achieved a Buyback ROI of 5.7% (the Buyback Strategy figure) with average trading skill. IBM bought at more peaks than valleys. The Q2 2013 purchase (see table above) is evidence of poor timing: it was the largest quarterly purchase that IBM had made in over a year and it was made when the stock had risen considerably.
It is always easy to criticize in hindsight and if the stock advances significantly in the future then the Buyback ROI will also improve significantly. However, it is clear that IBM could have put over $45 billion (and counting) to better use than buybacks. Most companies look for a return of 10-15% and IBM has failed that target recently.