Generally, I like it when a company announces a share buyback program, since it is an indication that the company values its shares higher than the market does and it believes the investment offers the best possible return on investment for the cash they are holding. The value of shares in investors' hands should also increase as the earnings per share do.
It works like this: If a company buys back an amount of its shares, the number of shares outstanding will decrease. All things being equal, especially total profit remaining stable, earnings per share will increase because there are fewer shares its profits need to be divided into. Like dividends, share buybacks return capital to investors, but the return is tax free.
When a company holds extra cash, it could apply it in a number of different ways. It could of course also hold the excess cash in its coffers to cover unforeseen misfortune, issue a one-time special dividend to shareholders, pay off debt, or invest in future projects or developments.
As it turns out, companies don't always get buybacks right. A record amount of buybacks took place in 2007 as the share market peaked with record high share prices, only to tail off dramatically when prices dropped in 2008, despite ample cash reserves.
According to Standard & Poor's Indices, buybacks in 2011 were only surpassed by 2006 and 2007, although circumstances appear to be different this time around. Companies are now generating three times the amount of cash, price-earnings ratios are lower and 10-year Treasury yields are only around 2%. It is unfortunately also a sign that growth prospects for the U.S. economy remain low, as companies are not investing in expansion projects.
We'll now take a closer look at five stocks that have undertaken serious buyback programs over the past decade and the value they've created for shareholders. Investors should note that buybacks are one of many factors of strength and can create a false positive by reducing the denominator in EPS. Please use this analysis as a starting point for your own research.
A Cash Cow With Milk to Spare
When a company generates healthy growing revenue with little or no capital or fixed asset expenditure, generous amounts of cash will become available. As is the case with Accenture plc (NYSE:ACN), it provides consulting, outsourcing and technology services to clients worldwide and, for the most part, is a boring but profitable business.
Accenture could always use its cash to pay out dividends to shareholders, but then it is already delivering a dividend yield of 2.4%. It could be bigger, but it chooses to reinvest in itself and create value for shareholders in that manner.
From 2007 up to last year Accenture spent an approximate $12.5 billion to buy back its stock. From 2007 to date Accenture stock has risen by more than 53%. Perhaps this growth can't be directly attributed to its stock buyback program, but they've achieved a margin of return of investment that's highly enviable.
In the Long Run Results Count
When The Home Depot Inc. (NYSE:HD) announced last March that it would buy back its own stock, the markets reacted unfavorably. It perhaps had reason to, recalling a similar announcement in 2007 that saw the company lose more than 30% of its share price despite the S&P 500 and Dow Jones Composite Average showing growth in excess of 5% that year.
The 2011 stock buyback program would see them buy back 15% of its common shares outstanding at a total of $10.7 billion and take the company halfway to its goal of buying back $22.5 billion in stock.
After initially losing ground, the share price rallied and is now trading around 23% higher. What's more, the share price has increased by more than 17% since 2007. I think the market might feel a bit silly about its skepticism.
Other People's Money
Taking advantage of the low yields on investment grade bonds, DirecTV Group, Inc. (DTV) sold $3 billion 5- and 10-year notes and $1 billion of 30-year debt to finance a $6 billion stock buyback program that was approved by the board in February last year.
This is to go with the 136 million shares it purchased for $5.11 billion in 2010. Since 2006 its shares outstanding have declined by 45%.
Its aggressive share buyback program has boosted its share price 46% in 2009, 20% in 2010, and a further 7% in 2011. More astounding still, since 2006 when the program started, DirecTV has seen a 95% increase in share price.
Investing for Life's Luxuries
Starwood Hotels & Resorts Worldwide, Inc. (NYSE:HOT) started its share repurchase program in 2006 at which point it foresaw growth in earnings per share through to 2009 of 20-23%. It turned out to be wrong, as we well know.
In December of last year it extended the share buyback program by a further $250 million. It's still too soon to tell if the repurchase program that was most recently approved will pay off, but let's look at the overall results dating back to 2006.
Over the first three years of the program the share price lost just over 67%. However, since 2009 it has grown by more than 130%. All in all, in the end its decision seems to have paid off.
These Chips Aren't Down
Although it has not had a beneficial effect on its share price yet, Marvell Technology Group Ltd. (NASDAQ:MRVL) announced in December last year that its board had authorized an increase to its share buyback program by a further $500 million to $2 billion. This is a shrewd move. The company has $2.4 billion in cash, its shares are trading near one-year lows, and its long term growth prospects are excellent.
In 2011, Marvell repurchased and retired over 79 million or about 12% of the outstanding shares. Watch how this creates value for shareholders over the longer term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.