Corequity provides independent, institutional equity valuation research. The results are used to screen for the best and worst values out of over 500 equities on a continuous basis. We have accumulated a proprietary database of historical monthly valuation data. For a brief background... http://corequity.blogspot.com/2013/05/some-background.html
Robert, I read with
great interest your recent blog post demonstrating the relatively low ROI's
required to replicate EPS growth from equivalent share buybacks.
Your analysis suggests profound flaws in the two most common rationales
corporate executives give for their share buyback programs
1.Our actions reward
shareholders by making their shares more valuable
2.Our stock is
undervalued. Our actions reflect management's confidence in our growth
potential
The first argument may
be true for EPS, but not for long term stock price appreciation. The second
argument is even more galling, as your analysis suggests exactly the
opposite. Given your results, the only logical explanation to go ahead
with an aggressive buyback program is that management actually doesn't
believe it can generate even modest returns on its cash from current
operations. Or said another way, management is in essence saying they are
giving money back to shareholders because they have run out of ideas on how to
generate attractive returns within the company. Or course, the more
likely explanation for share buybacks is management bonus kickers based
on EPS. So much for CEO's and boards acting in the best interest of
shareholders.
I teach business
strategy in the MBA program at Columbia Business school where I share a
perspective that effective capital allocation is one of the most important
responsibilities of the CEO. To illustrate the point, I point to IBM who
has skewed its use of capital (including debt financing) towards share buybacks
at the expense of value-creating investments in R&D and capex. As a
result, IBM's R&D lags its technology peers, and not surprisingly (despite
aggressive acquisition activity), its revenues have declined for 15 straight
quarters. The attached figure graphically depicts these trends.
HP is another case of
the folly of favoring share buybacks over R&D in the tech industry.
Carly Fiorina is often criticized for her disastrous acquisition of Compaq, but
her successor Mark Hurd also deserves notoriety for slashing HP's R&D
expenditures while sizably expanding HP's share buyback program.
Shareholders who
maintained their investments in both of these companies through their periods
of substantial share buybacks have not fared well.
I'd be curious to
learn whether you've done any analysis tracing the stock price performance
(relative to the S&P 500) of companies who have been most active in stock
buybacks. Has management unwittingly practiced buy high/sell low?!
Marissa Mayer, chief executive of Yahoo.CreditRamin Rahimian for The New York Times
It is one of the great investment conundrums of our time: Why do so many stockholders cheer when a company announces that it’s buying back shares?
Stated simply, repurchase programs can be hazardous to a company’s long-term financial health and often signal a management that has run out of better ways to invest in the business.
And yet investors love them.
Not all stock repurchases are bad, of course. But given the enormous popularity of buybacks nowadays, those that are harmful probably outnumber the beneficial.
Those who run companies like buybacks because they make their earnings look better on a per-share basis. When fewer shares are outstanding, each one technically earns more.
But a company’s overall profit growth is unaffected by share buybacks. And comparing increases in earnings per share with real profit growth reveals the impact that buybacks have on that particular measure. Call it the buyback mirage.
Consider Yahoo. The company bought back shares worth $6.6 billion from 2008 to 2014, according to Robert L. Colby, a retired investment professional and developer of Corequity, an equity valuation service used by institutional investors. These purchases helped increase Yahoo’s earnings per share about 16 percent annually, on average.
But a good bit of that performance was the buyback mirage. Growth in Yahoo’s overall net profits came in at about 11 percent annually.
Given these figures, Mr. Colby reckoned that Yahoo, if it had invested that same amount of money in its operations, would have had to generate only a 3.2 percent after-tax return to produce overall net profit growth of 16 percent annually over those years.
Some companies argue that the money they spend repurchasing stock is a shrewd use of their capital. And given Yahoo’s track record in recent years, its management team seems to have had a hard time identifying profitable investments.
But Mr. Colby pointed out that buybacks provide only a one-time benefit, while smart investments in a company’s operations can generate years of gains.
Yahoo declined to comment on its buybacks.
This analysis may be of interest to Starboard Value, an activist investor that is a large and unhappy Yahoo shareholder. On Thursday, Starboard nominated nine directors to replace the company’s entire board, saying its current members lack “the leadership, objectivity and perspective needed to make decisions that are in the best interests of shareholders.”
In a statement, Yahoo said, “The board’s nominating and governance committee will review Starboard’s proposed director nominees and respond in due course.”
Yahoo is not alone. Mr. Colby conducted a cost-benefit analysis of 26 companies buying back stock versus using that money to invest in a business.
He found that McDonald’s was another problematic example. Since 2008, McDonald’s has allocated almost $18 billion to buybacks. This has helped produce 4.4 percent increases in annual earnings per share over the period. To equal that growth in overall earnings, the company would have had to generate just a 2.3 percent return on the money it spent buying back stock, Mr. Colby estimated.
Last November, Moody’s Investors Service downgraded McDonald’s unsecured debt rating, citing its plans to increase its borrowings in part to fund future buybacks.
Becca Hary, a McDonald’s spokeswoman, said the company had a “balanced and disciplined capital-allocation strategy that promotes long-term value for our shareholders.” She cited McDonald’s plans to invest $2 billion to open a thousand new restaurants and “to reimage 400 to 500 locations” domestically.
In an interview, Mr. Colby said his research “confirms my suspicion that while buybacks are not universally bad, they are being practiced far more broadly and without as much analysis as there should be.”
Perhaps the crucial flaw in buybacks is that they reward sellers of a company’s stock over its long-term holders. That’s because a company announcing a repurchase program usually sees its stock price pop in the short term. But passive investors, such as index funds, and other long-term holders gain little from the programs.
Especially problematic are buybacks financed with borrowed money; repurchases of stock made at prices above its intrinsic value are also unwise.
Another hazard: companies that spend billions to repurchase stock without substantially shrinking the number of shares outstanding. That’s because in these circumstances, prized corporate cash is used to buy back shares that offset stock grants bestowed on company executives in rich compensation plans.
And there are plenty of companies whose buybacks have simply left them with less money to invest in more promising opportunities.
“By throwing away money on buybacks, companies are giving up on the ability to grow in the future,” said Michael Lebowitz, an investment consultant and macrostrategist at 720 Global in Chevy Chase, Md.
At last, some investors are stirring on this issue. Domini Funds, a mutual fund company, and the A.F.L.-C.I.O.’s investment funds have submitted shareholder resolutions on share buybacks at 3M, Illinois Tool Works, Target and Xerox this year.
The proposals ask the companies to adopt a policy of excluding the effect of stock buybacks from any performance metrics they use to determineexecutive pay packages.
“We’re not against buybacks,” said Adam M. Kanzer, a managing director at Domini. “The question is at what point do buybacks become excessive and when do they undermine the long-term value of the company?”
At 3M, for example, research and development expenditures plus strategic acquisitions have totaled $22 billion over the last five years, Mr. Kanzer said. In the meantime, the company’s buyback program has cost $21 billion.
“When the buyback almost equals all the other expenditures, it makes sense to ask questions about whether there’s a more constructive way to invest that capital,” Mr. Kanzer said.
Asked about these questions, Lori Anderson, a 3M spokeswoman, referred me to the company’s proxy filing, which stated, “We believe these concerns are unfounded, as demonstrated by our long-term track record and our balanced capital-allocation approach.”
A group of institutional investors will also convene soon to examine the pros and cons of buybacks. The Shareholder Forum, which conducts independent programs to provide information that helps investors make sound decisions, is starting a new program on the topic.
“You really have to ask why a company’s board decides to return a big chunk of capital instead of replacing managers with ones who can figure out how to develop the operations,” said Gary Lutin, who oversees the Shareholder Forum.
“If the board doesn’t think it’s worth investing in the company’s future,” Mr. Lutin added, “how can a shareholder justify continuing to hold the stock, or voting for directors who’ve given up?”
The Undervalued Screen was up an average of +2.9% while the
Overvalued were down -0.6% relative to the S&P 500 in February. This represents quite a change from January.
The gains and losses of those
stocks leaving the screens are even more dramatic. Stocks leaving the UV gained 8.2% relative
while those leaving the Overvalued declined by 9.3%.
