When you look at a company like Indianapolis-based health care plan giant Anthem (NYSE:ANTM), it's easy to see a profitable and growing company. On the bottom line Anthem has grown earnings per share from around $4.80 at the end of fiscal year 2006, to closer to $9.40 last year. And the share price more or less reflected this notion, moving from below $80 per share in 2006 up to $140 or thereabouts now.
It all seems reasonable enough. Yet the way in which this growth has been generated may be a bit surprising. Here's a look at Anthem's business and investment history over that period:
The top line saw reasonable growth - moving from about $57 billion up to $79 billion, good for an average compound annual growth rate of about 3.7%. However, once you start to look at company-wide earnings it starts to take a different turn. The number of sales had been increasing, but the quality of those sales as measured by the net profit margin has been decreasing. So much so that Anthem the company actually earned less in 2015 than it did in 2006 - $2.6 billion versus closer to $3.1 billion before.
Now this certainly is not to suggest that Anthem can't grow in the future, or that earnings will always be lower. However, I find it interesting to note nonetheless. Had you owned the entire company, your earnings claim would be less today than it was a decade ago.
If the number of shares outstanding remain the same during the period, the earnings-per-share growth will be equal to company-wide earnings growth. Out of any example in recent memory, nothing could be further from what has happened in this case. I used to think Travelers (NYSE:TRV) was the standard as far as large-scale share repurchase programs go. Anthem's results could very well be more impressive.
At the end of 2006, Anthem had about 615 million common shares outstanding. By the end of 2015 this number had been reduced all the way down to 261 million. That's a reduction of nearly 60%. Expressed differently, for every 5 shareholders that existed in 2006 just 2 remain today. The company bought out nearly 60% of the shareholders on your behalf.
And this makes a huge difference as far as the long-term owner's underlying earnings claim goes. Had the share count remained the same, they would have seen earnings-per-share decline by about 2% annually. The $4.80 in EPS during 2006 would have turned into $4.15 in earnings. Instead, shareholders saw their claim go from $4.80 all the way up to $9.40 - a yearly increase of nearly 8%.
From there, the valuation that investors were willing to pay decreased slightly resulting in share price growth of about 6.6% per annum. Anthem initiated a dividend in 2011, which now makes up about 28% of its trailing profits. If you put it altogether you come to a total return of just over 7%. As a point of reference, that's the sort of thing that would turn a $10,000 starting investment into $19,000 or so after nine years.
From the beginning and end points, it seems logical enough. Anthem grew earnings-per-share by 7% to 8% per year, and security had annualized gains in the 7% to 8% range as well.
Yet I think it can be instructive to see how the company got there. It wasn't due to impressive revenue growth or earnings growth - as we just saw company-wide earnings growth was actually negative. Instead, the major factor was a very effective share repurchase program.
This program was effective for three basic reasons: willingness, ability and valuation.
If you don't have the willingness to retire shares, naturally you're not going to retire shares. It sounds simply enough, and really it is, but occasionally you have situations like Cracker Barrel (NASDAQ:CBRL) where a share repurchase program may be difficult or not in the best interest of shareholders.
The second part is ability. This comes in two fashions: first, an ongoing profitable firm; which Anthem has certainly demonstrated itself to be. The second part of ability is the payout ratio. If most of your "organic" funds are going toward dividends, as an example, that leaves less funds that could be allocated toward buying back shares. In the case of Anthem, the company started out the period without paying a dividend and even now the cash payout makes us less than a third of profits. So the ability was certainly there. Anthem used upwards of an average of $3 billion annually in the last decade to reduce the share count.
Finally, the valuation at which you're buying out past partners is especially important for the effectiveness of a share repurchase program. The average earnings multiple for Anthem during this time has been around 11, and in many years - 2008 through 2013 - the P/E ratio was well below 10.
A lot of people like to see ever higher prices or valuations, but in this case the long-term owner has been served well by the lower valuation. Even if you did not add any new capital and you spent all of the dividend payments, you would still be a net buyer in the way of the company repurchasing shares. When it's doing so you'd much prefer for Anthem to buy out past partners at say 8 times earnings instead of 16. The "bang for your repurchase buck" is enhanced when this sort of thing occurs.
In short, if you're looking for a case study on share repurchases I think Anthem fits that mark exceptionally well. The company itself has experienced negative overall earnings growth and yet shareholders have seen their underlying earnings claim increase by nearly 8% per year for going on a decade. Moving forward there are apt to be less "organic" funds to go toward share repurchases and the effectiveness decreases as the valuation rises, but this still should be an important area of consideration for the current or prospective investor.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.