- Share repurchases increased 50% in the first quarter, standing at $155 B. It is the third largest amount ever spent on share repurchases.
- Investors should pay great attention to the efficiency of the share repurchases. If they are not executed correctly, they waste the money of the shareholders.
- Gathering the data of the first semester, I assorted the most popular companies that perform significant buybacks based on their efficiency.
In the current 5-year bull market, the share repurchases become more intense as the stock market rises. To be sure, the quarterly amount of the share buybacks rose 50% in the first quarter (vs. Q1-2013), standing at $155 B. It is the third largest quarterly amount ever, with the all-time high being the $180 B that was spent at the peak of the previous bull market in 2007.
As I have described in a previous article, although the share repurchases are much more efficient near the bottom of the market, in reality the companies prefer to spend their cash on investment projects near the market bottom while they enhance their share repurchases at much higher stock prices, as they normally have fewer promising investment projects at that phase of the economic cycle.
As the market hovers around its all-time highs, it is evident that the share buyback programs of some companies are not efficient. Even worse, some companies use the share buybacks only to mask their declining earnings, trying to improve their earnings per share (EPS) in this way. It is even worse that some companies purchase their shares at a high P/E ratio, which results in a very poor use of the company's cash. Usually, when a company buys its shares at a high P/E (e.g. higher than 17), it also increases its debt load, thus reducing the perspective of its future earnings.
Therefore, it is very important for investors to check whether the earnings of a company grow along with the EPS and also at what price levels (P/E) the share repurchases are performed. To this end, I gathered the data for the 1st semester of this year vs. the 1st semester of last year for most of the well-known companies that repurchase their shares at a significant rate. The results are shown below in order of descending EPS growth:
% decrease in share count
% EPS growth
It is evident from the table that International Business Machines (NYSE:IBM) exhibited the best performance, as its EPS grew much more than its buyback rate, while its buybacks were executed at a remarkably low P/E. Dun & Bradstreet (NYSE:DNB) and Lyondell (NYSE:LYB) exhibited great growth too and purchased their shares at a reasonable P/E. The same can be claimed for AutoZone (NYSE:AZO), Viacom (NASDAQ:VIAB), American Express (NYSE:AXP), Exxon Mobil (NYSE:XOM), DirecTV (NASDAQ:DTV), Apple (NASDAQ:AAPL) and Torchmark (NYSE:TMK), though their EPS growth was lower than that of the first three companies.
On the other hand, while Home Depot (NYSE:HD), Visa (NYSE:V) and O'Reilly (NASDAQ:ORLY) exhibited great EPS growth in H1-2014, their buyback programs were performed at high P/E levels. Such buyback programs usually waste the earnings of a company, as they contribute little to the stock value. Nevertheless, even such extravagant programs have a chance of proving beneficial to the shareholders if the future earnings of the companies turn out to be much higher than their current earnings. The analysts' consensus projects significant growth of 15%-20% for the next two years for these three companies so there is a chance that their current buyback programs add some value to their stocks.
Other companies, such as General Mills (NYSE:GIS), Oracle (NYSE:ORCL), AT&T (NYSE:T), Bed Bath & Beyond (NASDAQ:BBBY) and Fossil (NASDAQ:FOSL) saw their net income decline in H1-2014 and repurchased a portion of their shares just to "mask" that decline and report flat or slightly negative EPS growth thanks to these repurchases. If this pattern repeats itself in the next quarters, then the share repurchases of these companies will waste the earnings just to stabilize the EPS and the stock price, which should not make the shareholders of these companies happy.
The worst companies were those with a significant decline in their EPS (9% or more) despite their significant share repurchases. Philip Morris (NYSE:PM) has not shown any earnings growth in the last 3 years (including 2014) and has used the extensive share buybacks only to stabilize its EPS at the expense of a growing debt load and a negative book value. Even worse, it has repurchased its shares at relatively high prices (P/E=16), as investors tend to pay a premium for this stock. WellPoint (WLP) and Raytheon (NYSE:RTN) experienced similarly poor performance to Philip Morris but they are expected by analysts to grow in the second half of the year while they also possess a much healthier balance sheet than Philip Morris.
Herbalife (NYSE:HLF) incurred the worst EPS decline even though it bought 11% of its shares in the last 12 months. This does not bode well for the performance of the company, which should definitely improve to reward its shareholders. Fortunately, due to the inherent risk of this stock, the shares trade at a very low P/E, which makes the share repurchases efficient, as long as the earnings will revert to their previous levels at some point in the future.
To sum up, investors should closely monitor the efficiency of the buyback programs of their stocks. When a company chooses to spend most of its profit on share buybacks, this means that it invests very little on growth projects. Therefore, its shareholders can expect EPS growth only from the share repurchases and hence these should be performed at a low P/E, otherwise most of the profit of the company is wasted, thus downgrading the future earnings of the company.