Saj Karsan has published a blog post on the poor timing of corporate share buyback programs. He observes that companies often repurchase their shares when the market is most enthusiastic about their prospects, and the share prices are correspondingly high. While Saj makes an excellent and important point, I want to defend some of the companies he cites as examples in his post.
A share buyback is a way for a company to allocate capital that cannot be productively deployed in its operations. The company can pay the money out as a dividend, or use it to repurchase some of its stock. By reducing the number of outstanding shares, the company increases the share of future earnings that an ongoing investor will receive. Is this increased share of future earnings worth the money spent on the stock repurchase, or would shareholders be better off simply receiving a dividend?
The decision by a company to repurchase its own stock can be viewed as any other investment decision. Instead of buying its own shares, the company could have purchased shares of another business, which would have also contributed to future earnings of the company's shareholders. So whether a buyback is a good investment comes down to price. Companies should only repurchase their shares if those shares are undervalued.
As Saj points out, the overall record is not good. Companies tend to repurchase their shares at the wrong time, when the share prices are high, and to slow down their repurchases when the share prices are, in fact, attractive. This is understandable: Prices are generally high when companies have strong earnings and thus have money to spend on buybacks. But it is not excusable, as it wastes shareholder equity.
At the same time, long-term buyback records are quite rational for several companies that Saj cites as examples of poor buyback timing in the near-term. Let's look at Lowe's (LOW). Here is how the number of outstanding shares of LOW has been changing over time:
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We see that Lowe's has been buying back its shares between 2006 and 2008, and then again in 2010. Share buybacks were apparently on hold from 2008-10. This timing is indeed imperfect, since LOW shares were cheaper between 2008 and 2010 than in the years immediately before or after. However, let's put this in the longer term perspective. Here is a look at LOW's price-to-book ratio for the past 16 years:
Since 2007, the price of Lowe's shares has been low by historic standards, compared to the value of underlying shareholder equity. While Lowe's may have started buybacks too early, and has not perfectly timed those purchases to the short-term market swings, its long-term timing is quite reasonable.
A similar picture emerges when we look at Wal-Mart (WMT).
WMT had significant buybacks between 2003 and 2005, in 2007, and after 2009. Looking at its P/B ratio, we conclude that the relative price may have been too high in 2003, but certainly looks reasonable in more recent years.
Timing of corporate share buyback programs is an important consideration in making stock investment decisions. Companies that overpay for their own stock destroy shareholder value, and should be avoided. Companies that repurchase shares when the price is right create additional value for their investors, above and beyond the value generated by the underlying business.
Disclosure: I am long LOW.