Stock Buybacks That Actually Create Value

Includes: AZO, BBBY, DLTR, LO, PM, V
by: The Conservative Income Investor

A little while ago, Carol Loomis of Fortune Magazine wrote an article titled "Beating The Market By Buying Back Stock" that performed a case study on companies buying back large blocks of stock and actually retiring the shares. In her report of the results, Loomis offered this analysis of the results for companies that bought back large chunks of their own stock:

"Working with the 1,660 stocks covered by the Value Line Investment Survey, we identified companies that bought significant amounts of their own common stock in the ten years from 1974 through 1983. Next we reduced this list to voluntary repurchasers -- cutting out, for example, companies that had bought the shares by paying "greenmail" to get rid of a threatening shareholder. Then we measured the total returns (stock appreciation plus dividends) earned by shareholders from the approximate dates of each repurchase "episode" to the end of 1984. For exactly the same periods, we compared the results with total returns earned on Standard & Poor's 500-stock index, a generally accepted indicator of "the stock market."

The outcome is spectacularly decisive. The shareholders in the buyback companies earned superb returns, far exceeding those accruing to investors as a whole. For all episodes measured, the buyback companies showed a median total return, expressed as an annual average, compounded, of 22.6%. The equivalent return for the S&P 500 was only 14.1%. That difference of 8.5 percentage points is enormously significant to an investor: at 22.6%, a stake of $1,000 grows to $7,670 in ten years; at 14.1%, it grows to only $3,740. Clearly, the managers of the buyback companies, in aggregate (though certainly not in every instance), added heroically during these years to the wealth of shareholders who remained in the fold."

In the Fortune magazine case study, Loomis and her research team defined "stocks with meaningful buybacks" as those companies that repurchased at least 4% of their total share count. The companies that generated the most value with their share buybacks tended to have three characteristics in common: the company was undervalued, the amount of the announced buyback was large, and the company actually retired the amount of shares (or nearly the amount of shares) that the company promised.

When we review the last decade, the buybacks that created the most value for shareholders managed to combine these three factors. The best buyback program since 2004 has come courtesy of Dollar Tree (NASDAQ:DLTR), which has managed to generate 34% annual returns with its buyback program by spending $1.9 billion to buy back stock worth $6.9 billion. Lorillard (NYSE:LO) bought back 42 million shares and earned a 27.7% annual return on its buyback program. Visa (NYSE:V) has generated 32% annual returns on its buyback program. Philip Morris International (NYSE:PM) bought back $21 billion worth of stock that is worth $35 billion, generating 26% annual returns on its buyback program (Philip Morris International may be one of those companies worth watching over the next decade because it seems to be one of those companies that blends a perfect symphony of earnings growth, significant stock buybacks, and growing dividends to take care of shareholders over the medium term).

Autozone (NYSE:AZO) has run an aggressive buyback program (often requiring significant debt to do so, which makes the company less attractive to some conservative investors) that has drastically reduced the share count. The company has bought back over 55 million shares since 2004, and the company currently has only 36 million shares outstanding. The company has generated 26% annual returns on its buyback program.

Right now, I am keeping my eye on Bed, Bath and Beyond's (NASDAQ:BBBY) announced stock buyback program. The company has committed to buying back $2.7 billion worth of stock over the next two to three years, and the company has a total market cap of $14.6 billion. At best, this buyback program may reduce the share count by 15-20% depending on the prevailing market prices over the coming years that will determine the success of the repurchase plan. Considering that the company is trading below 15x earnings (which is below the typical P/E valuation this decade) and is poised to grow earnings by a 10-15% rate over the medium-term, this buyback program may prove lucrative to shareholders if executed well.

Paying attention to the buyback announcement of companies can prove lucrative if you are an investor that has time to monitor the successful application of three factors: the stock is trading at a low to reasonable price during the time of the buyback, the amount of the stock buyback plan is meaningful, and the company actually retires the shares promised. If you can keep your eye out for companies that do those three things well, you may reap the kinds of returns that Carol Loomis boasted about in her Fortune case study.

Disclosure: I 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.