Our Net Profit Test:
Comparing Buybacks to Investment shows that a company’s purchase of its own
shares causes a single increase in EPS (as in simple interest) compared to
compounding growth that results from investment. This graph shows the annualized returns of
the two asset allocation decisions over time. The sinking annualized return on a buyback explain the relatively low level of return required to grow the Net Profit at the rate that the buybacks achieved due to the fewer number of shares.
(See “Net Profit Test:
Comparing Buybacks to Investment” at corequity.blogspot.com)
The sinking annualized return on a buyback explains the relatively low level of return required to grow the Net Profit at the same rate that a buyback achieves due to the fewer number of shares.
To illustrate the advantage of Investment over Buybacks, here
are two very similar companies who couldn’t be further apart in their asset allocation
choices. The two are Cracker Barrel
(CBRL) and Jack in the Box (JACK). They
are both mid-cap Restaurant companies trading at 19x earnings.
|
Company
data as of May 31st
|
CRBL
|
JACK
|
|
INDUSTRY
|
RESTAURANT
|
RESTAURANT
|
|
MARKET CAP
|
MID-CAP = $3.5 B
|
MID-CAP = $2.4 B
|
|
P/E
|
19x
|
19x
|
|
YIELD
|
3.1%
|
1.6%
|
|
2008-15 CASH FLOW - DIVIDENDS
|
$1.27 bil
|
$1.23 bil
|
|
2008-15 STOCK BUYBACKS
|
-$0.16 bil
|
-$1.20 bil
|
|
2008-15 CHANGE IN SHARES
O/S
|
+7%
|
-37%
|
|
GROWTH OF EPS 2008-2015
|
+144% or +13.6% pa
|
+50% or +6.0% pa
|
|
GROWTH IN NET PROFIT “
|
+151% or +14.0% pa
|
-4% or -0.5% pa
|
|
REQ’D AFTER TAX % TO = EPS
GROWTH[1]
|
-
|
4.8%
|
CBRL’s Cash
Flow from Operations less Dividends totaled $1.27 billion from 2008 and
2015. Most of this was invested in its
operations as indicated by its book value per share which grew from $4.15 to $22.45.
As a result of this investment, their Net Profit growth equaled the growth in EPS
over the 7 years (+14.0% vs +13.6%) as their shares outstanding increased
slightly.
By contrast, JACK bought $1.2 billion of their own stock,
reducing their shares outstanding by 37%. As a result their EPS grew by 6.0% pa
entirely due to buybacks but their Net Profit actually declined by 3.7%, or -0.5%
pa.
The Shareholders of JACK today would have been much better
off had management invested those funds - as much as that may have made the Sharesellers
happy. The company would only have to earn
a 4.8% return on those funds for the Net Profit to match the “growth” in EPS (the
Net Profit Test). That would have
generated $64 million more in Net Profit in 2015 alone, or 56% more than they actually
achieved ($178 million vs $115).
Much has been said about the role of share buybacks in
executive stock options. It is therefore
interesting to note how much these two companies compensated their senior
management. In 2015, Jack in the Box led
by $16.6 to $13.8 million[2]. The five year average number is closer but
JACK still wins: $9.9 to $9.6 million.
In JACK’s case, management is clearly not being judged by
the Net Profit Test.
© 2016 Robert L. Colby June
23rd 2016
No comments:
Post a Comment