This document puts forward best practices for discussing past and future stock buybacks on Seeking Alpha. Buybacks are a way of returning capital to shareholders and therefore constitute a major aspect of investment analysis. Below, we discuss the important information that authors should share when discussing buybacks and ways in which this information should be interpreted.
Since 1982, corporations have been able to repurchase their own stock without a formal tender, provided that repurchases do not make up more than 25% of dollar-based trading volume on any given day, with some exceptions for large block transactions (see Rule 10b-18). Before the 1982 "safe harbor," stock repurchases were considered a market manipulation under the Securities and Exchange Act of 1934.
Share repurchases before the change in regulation were conducted through tender offers. One such tender offer from Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) in 1964 frustrated a young Warren Buffett so much that he purchased a controlling interest in the firm (see The Snowball, p. 272-273). Other well-known examples include the tender offers by Henry Singleton of Teledyne between 1972 and 1984 (for more, see this discussion).
Discussing past buybacks revolves largely around providing historical information and passing judgement on the investment activity. For past buybacks, we suggest authors consider the following points:
Suggestions for analyzing past share repurchases
Discuss the average share price of past share repurchases. Simply stating the size of a past buyback or merely saying one happened does not give the reader enough information for them to judge the quality of the buyback.
Indicate whether you believe the share repurchases were prudent, as this may reflect on the success or failure of future repurchase programs.
Discuss the size of the repurchases relative to the shares outstanding of the firm at that time. In addition to discussing the prices at which past buybacks took place, this gives readers a sense of their magnitude.
More important for our readers is the forward-looking analysis of an ongoing or upcoming buyback programs. We suggest that authors apply the following points of presentation and interpretation:
Suggestions for analyzing future/current share repurchase programs
Stock repurchases do not mean that the stock is undervalued. Undervaluation is determined by an independent evaluation of the security separate from the buyback.
It is worthwhile to note the size of the buyback authorization and your best guess of whether management will follow through with the buyback program.
If there is an authorization of X dollars, it is useful to state that Y% of the company can be repurchased "under the authorization if the shares persist at the level of $Z per share." In these cases, it is conservative to assume that the repurchases will take place at some hypothetical market price which is slightly higher than prevailing prices. This builds in a margin for error in the estimate.
Share repurchases are a use of capital and they lower the cash and securities that a firm holds. Buybacks will change the composition of the balance sheet via a decrease in cash and book value. If funded with debt, repurchases both decrease book value and increase liabilities - this can affect the debt to equity ratio to the point of distorting its meaning. In some cases, these effects are material to a forward-looking analysis and should be taken into account.
How do buybacks create value?
For repurchases to create value, they should be viewed by management as another type of investment spending, namely, the buyback should be judged on its potential to increase the value of the firm's earnings on a per share basis relative to other uses of capital.
Since what is being invested in is the firm's own common stock, the language of common stock investment should be employed, namely, that share repurchases should be done at levels equal to or below intrinsic value to create the most value for continuing shareholders. If repurchases cannot be done at these levels, it may be better for the corporation to pay a special dividend and let the shareholder's figure out what to do with the capital.
According to theories of modern finance, repurchases cannot increase the total enterprise value of a company, i.e., the total value of the equity interest and the debt interest, net of excess cash. Equity investors, of course, only care about the equity value. Therefore, repurchases funded with debt can redistribute value to the equity holders provided the debt and interest charges do not impair the value of the equity.
If one assumes a buyback is funded out of earnings or cash on hand but done at prices above intrinsic value, it may still create value for shareholders since it will ultimately lower the number of shares outstanding, benefiting continuing shareholders. If share repurchases are funded through debt and done at prices above intrinsic value, these repurchases are less likely to create value for the remaining shareholders.
An ideal buyback, given all the above, is one which is done with cash on hand at prices below the firm's intrinsic value.
Where can I find details on corporate repurchases?
Search "share repurchases" in a corporation's 10-K. Details are usually furnished in sections which discuss the equity portion of the balance sheet or are provided in a separate section in the notes. For example, Apple (NASDAQ:AAPL) discusses their share repurchase program in their 10-K under the headings "Share Repurchase Program" and "Capital Return Program."
What are treasury shares?
Treasury shares are a legal and accounting name for shares which were issued by the company at one point and which were bought back by the company but have not been retired. These can be retired or cancelled by the company or they can be reissued. For all intents and purposes, the accounting treatment for treasury shares under US law is arbitrary and therefore, irrelevant for most analysis. Other countries may treat treasury shares and stock repurchases differently than the US.
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