When a company buys back its own stock, we often like to write about how great that is -- or, how bad that is, depending on the opinion of the writer. What we don't often see is a quantitative analysis of what the return for the company actually was for past buybacks.
It is important to calculate the Buyback ROI (return on investment). If a company could use cash to expand the business at a rate of x and the buyback return computes to a rate of y, then, as a shareholder, you want to see y > x. That is obviously a bit of oversimplification. There are other factors for company management to consider when it comes to buybacks. However, a solid rate of return compared to other options should be very high on the priority list.
When a company buys back stock and the price rises, that is good! It will achieve a positive Buyback ROI. When the stock goes lower than the buyback price, that is bad! The company's Buyback ROI will normally be negative in that case. Note that saved dividend payouts can push the Buyback ROI into positive territory, even if the stock goes lower from the buyback point.
I won't go into the nitty-gritties of the math behind all the calculations. For those that wish to know how I attained the figures below, I highly recommend this article that explains it quite well. I will summarize the calculations, which should be sufficient for those readers with an understanding of the principles.
Apple's Recent Buybacks
Apple (NASDAQ:AAPL) has been very aggressive in buybacks over the last 6 quarters. Here is a graph of the outstanding shares:
AAPL Shares Outstanding data by YCharts
Apple spent about $34.0 billion over the last 6 quarters on stock, and the value of those shares as of Q1 2014 was about $36.4 billion. That equates to a total gain of about 7%, but does not tell us the annualized gain of either the shares themselves nor the $670 million in dividend payouts saved during that time. To get a figure that is meaningful, we need to do the slightly painful calculation of the Buyback ROI.
Looking at the last 6 quarters reveals the following history:
|Time Period||Shares Bought (in 1,000s)||Avg. Price of Purchase|
(Source: AAPL 10-Q and 10-K filings)
Note: Apple conducts ASR (Accelerated Share Repurchase) agreements from time to time. In this arrangement, the company pays a financial institution in advance to conduct share repurchases, which are not realized as share retirements until later. That is why the numbers in my table above do not match up exactly with the YChart graph above. The timing is different. For the purposes of this article, I need to use the time of payment, not of the time that shares are retired.
The following steps are taken to determine the Buyback ROI:
- For each quarter, multiply the shares bought by the avg. price = amount spent.
- Multiply the cumulative shares bought by the dividend paid that quarter = dividend payout saved.
- Add the dividend payout saved to the amount spent = cash inflow (or outflow) for the quarter.
- Repeat steps 1-3 for the 6-quarter analysis.
- For the last quarter, multiply the cumulative shares purchased by the final quarter share price, and add that number into the cash inflow (or outflow) for the quarter. This is the final value of all the shares the company purchased.
- Finally, all of the 6 calculated cash inflows (or outflows) are run through an internal rate of return calculation to produce the Buyback ROI figure.
For APPL, in the last 6 quarters, the Buyback ROI was a pretty healthy 17.6%.
By comparing the Buyback ROI to the "Buyback Strategy" and to the "Buyback Effectiveness", we can how well the company picked the exact timing of the buybacks it made. The article that I linked above uses those two terms to mean the following:
- Buyback Strategy: The CAGR of the total return of the stock during the time of the analysis. This can be thought of as the "baseline" ROI number that the buyback would have achieved if the stock had no peaks or valleys. In other words, if the stock simply moved in a straight line, this would be identical to the Buyback ROI.
- Buyback Effectiveness: A comparison of the actual Buyback ROI to the Buyback Strategy: (1 + Buyback ROI) / (1 + Buyback Strategy) - 1. If a company has a positive Buyback Effectiveness, then it did a good job buying on the dips and avoiding the peaks. Think of this number as a scorecard measuring the short-term trading ability of the company.
Our final figures are as follows:
Buyback ROI: 17.6%
Buyback Strategy: 8.0%
Buyback Effectiveness: 8.8%
You can see from the figures above that Apple has achieved a reasonable ROI from its buybacks, as of the Q2 price of $75.24 per share. Of course, the stock is up considerably since then, so a sneak peek is in order. Assuming the stock stays at its current price of $90.33, then the figures in the upcoming Q3 will be as follows:
Buyback ROI: 39.9%
Buyback Strategy: 20.5%
Buyback Effectiveness: 16.2%
There are many other factors of buybacks to consider whenever evaluating any company. Does the company use a lot of stock options to pay employees? Are the buybacks used as a desperate measure to bump up EPS for a business that has slow growth? The list of pros and cons for buybacks is long and eminently debatable. Those are important, but are beyond the scope of this article.
The main priority of a company buyback should be to get a return on investment that is better than other options for the funds. Buying back stock when it is undervalued is an excellent use of cash (or even low-cost debt, up to a point). Apple has gotten good "bang for its buck", and as a shareholder, I am pleased with its buyback strategy.
Disclosure: The author is long AAPL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.