Summary Share repurchase programs are best done when they complement rather than compete with dividends. Buying back stock is like buying any other asset. Calculating a return on the cost is a useful metric for judging the impact to shareholder value. A buyback program should be reviewed in the context of spending alternatives and the impact to the capital structure. I’ve read many insights about the appropriateness of buyback programs over the years. Many rightfully argue that corporations are propping up earnings per share by reducing share count. Dividend investors argue that buybacks should be eliminated with excess cash returned in the form of higher dividend payments. An excellent blog published by NYU professor Aswath Damodaran reviews capital allocation options at various growth stages of a business. Linking the generation of free cash flow to cycle maturity and growth investment opportunities can be seen in his graphic below.  Logically a company having excess accumulated and generated cash flows has a duty to deploy it to the benefit of owners. The deployment choice is an interesting one, but the decision to invest internally is beyond the scope of this article. Instead, this article will explore the effectiveness of the decision to return cash to shareholders by looking at three companies: #IBM (IBM), #Intel ( #INTC ) and #Microsoft ( #MSFT). These companies were chosen because they have similar attributes. All three are mature and trying to reaccelerate growth in the cloud and Internet of Things. The decision to focus on technology is consistent with FactSet reporting that IT is the buyback leader.  It’s also worth noting that FactSet reports the total amount of buybacks has started to decline recently after a lengthy upward trajectory. Advertisement   Methodology The approach I used to calculate the return on investment in company stock is as follows: The net cost of the annual buyback is equal to the amount paid less any dividend savings for that year. The net cost for the cumulative calculation is equal to the amount paid less any dividend savings from date of buyback through the June 2017 quarter. The amount spent and shares repurchased were found in company SEC quarterly filings. The annual return is the difference between the year-end share price and the net cost per share purchased. This metric is intended to measure the timing effectiveness of interim purchases within the buyback year. The cumulative return for each buyback year is the difference between the current share price and the net cost per share purchased. This provides a longer term perspective. IBM 2012 2013 2014 2015 2016 2017 1H CYE price $191.55 $187.57 $160.44 $137.62 $165.99 $142.94 Shares M 61 73 72 30 23 16 Net cost 1yr $195.24 $190.43 $186.34 $153.69 $147.01 $164.66 1 yr. return (2)% (2)% (14)% (10)% 13% (13)% Net cost cum $173.91 $172.80 $172.94 $145.29 $144.11 $164.66 Cum return (18)% (17)% (17)% $(2)% (1)% (13)% Dividend paid $3.30 $3.70 $4.23 $5.00 $5.50 Dividend growth 12% 14% 18% 10% IBM notes: Buyback program did not appear to impact dividend growth. The number of shares purchased in 2012-2014 was much higher than seen in 2015. Poor execution of overall program to buy less when prices are relatively lower. The return on net buyback cost is negative in every year except 2016. The cumulative return for each year is negative relative to the current share price. The balance sheet at calendar year 2011 shows net cash (cash less debt) of ($19)B and equity of $20B. The balance sheet as of June 30, 2017 has net cash of $(33)B and equity of $18B. Conclusion: IBM has seen a modest deterioration of capital structure during period covered. Intel 2012 2013 2014 2015 2016 2017 1H CYE price $20.62 $25.96 $36.29 $34.45 $36.27 $34.84 Shares M 191 94 332 96 81 73 Net cost 1yr $24.73 $22.60 $32.24 $31.12 $31.79 $35.53 1 yr. return (17)% 15% 13% 11% 14% (2)% Net cost cum $20.4 $19.17 $29.71 $29.55 $31.26 $35.53 Cum return 71% 82% 17% 18% 11% (2)% Dividends paid $0.87 $0.90 $0.90 $0.96 $1.04 Dividend growth 3% 0% 7% 8% Intel notes: Buyback program was prioritized over dividends in 2014 as a significant increase was seen in buybacks with no dividend increases declared. The number of shares in 2012 and 2014 were substantially higher than in other years. The cumulative returns for 2012 indicates this was a good capital allocation decision. 2014 increase is less compelling as share price has not improved since the end of that year. The return on net buyback cost was significantly negative in the first year only. Each year shows a cumulative positive return on net buyback cost. The balance sheet at calendar year 2011 shows net cash (cash less debt) of $3B and equity of $46B. The balance sheet as of June 30, 2017 has net cash of $(17)B and equity of $69B. Conclusion: Intel capital structure was not significantly impacted given increase in debt is similar to increase in equity. Microsoft 2012 2013 2014 2015 2016 2017 1H CYE price $26.71 $37.41 $46.45 $55.48 $62.14 $72.66 Shares M 156 167 161 364 261 48 Net cost 1yr $29.28 $32.69 $42.57 $45.83 $54.42 $66.28 1 yr. return (9)% 14% 9% 21% 14% 10% Net cost cum $23.62 $28.00 $39.3 $43.58 $53.64 $66.28 Cum return 208% 160% 86% 67% 35% 10% Dividend paid $0.83 $0.97 $1.15 $1.29 $1.47 Dividend growth 17% 19% 12% 14% Microsoft notes: The annual dividend growth has remained in double digits through the buyback period. The 1-year return on net buyback cost was negative in 2012 only. All other years show a positive return. The cumulative returns are significant. Buybacks for 2015 and 2016 were increased over the prior years. No real change in returns. The buyback commitment for the 1H of 2017 is substantially lower than in prior years. This is likely a result of the purchase of LinkedIn for cash as opposed to a conscious belief the share price doesn’t warrant purchase but worth watching in the future. The balance sheet in 2011 shows net cash of $40B and Equity of $64B. As of June 30 2017, both balances are modestly higher indicating no change in capital structure. Conclusion The above approach is one I developed to analyze the effectiveness of company buyback programs. My total return investing approach leads me to evaluate the impact on dividend growth, capital structure and buyback discipline. Based upon this approach, I view the effectiveness of these companies as follows: IBM shareholder value has diminished as a direct result of their buyback program. They appear to primarily be motivated by improving their earnings per share by reducing the number of shares outstanding. Intel shareholder value was modestly improved as a direct result of their buyback program. Microsoft shareholder value was substantially improved as a direct result of their buyback program. These are my opinions only and do not constitute investment advice. The numbers in the above tables have not been reviewed by anyone and could contain errors. Disclosure: I am/we are long MSFT, INTC. 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.
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