Here's a fun tidbit of information: during the first quarter of 2016, Wells Fargo (NYSE:WFC) reduced its number of common shares outstanding by 16.2 million, at an average price of around $68. Why is that a fun fact? Well, from the beginning of this year to now, shares of Wells Fargo have exchanged hands anywhere from the mid-$40s to the mid-$50s. Never once did the shares reach the high $60s. So what's going on here?
That's a good question, and I'm glad you asked. Recently, I was reviewing Wells Fargo's 1Q16 Quarterly Supplement that came with the most recent earnings announcement. In general, I'd contend there's a lot to like about the investment. Naturally, everyone won't agree, but you have a formidable enterprise attached to a security trading with a 3%+ dividend yield to go along with a lower comparative payout ratio and valuation.
Moreover, you can pick out things that grab your attention. For instance, here's a look at the company's deposits as highlighted on page 10 of the supplemental report:
Wells Fargo has $345 billion in noninterest-bearing deposits. Interest-bearing deposits make up about $874 billion, for a total of just over $1.2 trillion. So, with nearly 30% of its deposits, the company doesn't have to pay anything to the customer (and indeed, many customers pay them). And even on the portion where interest is paid, the average deposit cost is just 0.1%.
Think about that. This analogy doesn't work perfectly, due to a number of factors (including outside expenses), but that's sort of like handing me $1,200 and then charging $1.20 to use the funds for the year. I'm pretty sure I could generate a positive return under that arrangement, even if I'm only allowed to use a portion of those funds to do so.
Moreover, should rates rise in the future, the amount of interest paid to customers could increase, but so too could the rates the company charges. So, nothing that I am about to say should be misconstrued as a negative sentiment about Wells Fargo - it's formidable. However, I would like to expand upon this article's opening.
On page five of the supplemental report, Wells Fargo stated this line:
A lot of people see a line that and think, "That's nice, the company retired shares, that's a bigger slice of the pie for me." And then move on to the next blurb.
This was my thought: "$1.1 billion sure sounds a lot higher than $800 million." I knew the share price of Wells Fargo had been hovering around $50 or so for the quarter (maybe slightly higher, maybe lower, but that's a good mental baseline). If it retired 16 million shares at $50, that would cost about $800 million. Yet, that's not what Wells Fargo indicated. Instead, the company said it spent $1.1 billion to decrease the share count by 16.2 million. So again, what's going on?
If we skip ahead to page 22, we have our answer:
16.2 million shares is the net number. The company didn't just buy back shares. Instead, it was a combination of issuing shares and buying back shares - with the amount retired being greater than the amount issued.
The 10-Q for the first quarter doesn't usually come out until May, but we don't need it to complete the illustration. We'll use round numbers, acknowledging that this is not what exactly happened, but probably a reasonable approximation.
Let's suggest Wells Fargo purchased the 51.7 million shares at an average cost of $50 per share. This leads to total share buying expenditure of about $2.585 billion. In order to get that number back down to a "net" of $1.1 billion, the company would have needed to receive ~$1.485 billion in proceeds for the stock it issued. Based on the 35.5 million shares it issued, the average price of the stock it issued would be around $41.80.
So in this example, you would be issuing 35.5 million shares at around $41.80 per share as part of the employee benefit program and then turning around and buying back 51.7 million shares at a price of $50. Again, the exact numbers are not likely to match (and you would be doing these items simultaneously), but the basic notion is on par. At the end of the day, it cost Wells Fargo $1.1 billion to get the share count down by 16.2 million shares.
That's how it has an average "retired price" of $68 when the shares never traded near this mark. Wells Fargo isn't trying to fool you, but I think this is an important difference nonetheless. Often when we think about a share repurchase program, we think about the company buying shares at the market price. Yet, it's also important to consider the net offsetting effects that can take place simultaneously.
This sort of thing can have ramifications on your future expectations. If you're dealing with a company that does not issue shares and only retires them, you can think about what the future price might be and how the current program might reduce the number of shares outstanding. This is a common way to think about it.
However, if you have a company that both issues and retires shares - for instance, Wells Fargo - there's a bit more to it than that. If you ignore the issuance part, you might wake up one day and find out that not as many shares have been retired as you originally suspected. For these types of companies, a secondary consideration is at play. So, in developing your expectations about the effectiveness of a share repurchase program, you might want to adjust your average purchasing price upward.
For instance, instead of presuming that shares might be retired at say $55 this year, you could instead use a more conservative number like $70. This reduces the number of shares that you'd anticipate being bought back, and simultaneously slows the per share growth rate a bit. It doesn't mean this should stop you from investing, but it is something that ought to be accounted for nonetheless.
Disclosure: I am/we are long WFC.
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.