How Effective Are Share Buybacks?

Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I have always been skeptical of share buybacks. I have always preferred to have the cash paid out to me through dividends rather than the company try and buy back its shares in the open market - often at the wrong price.  

Share buybacks are designed as a way of returning cash to shareholders, effectively reducing the number of shares available therefore pushing up the company’s EPS. As a result the higher EPS should lead to higher a share price, although it does not always work like that. As shares in a public company are freely traded and as a result they will trade with the market, therefore, if the market as a whole is in a bear down trend then the sock will not react to the buyback and investors will lose out.

On the other side of the argument are stocks like Philip Morris – companies that are trading in a declining revenue environment. These companies have no choice but to buy back stock or face every declining earnings as sales volumes are eaten away by in this case changing tobacco opinions.

Even though share buybacks are designed to return cash to shareholders in many cases they are a complete waste of hard earned company cash. This cash could be better put to work on reducing debt or improving gross margins. Some of the biggest culprits are HP and Intel:

 Bad Buybacks

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Total Buyback</p> </td> <td> <p>Total Shares Brought Back</p> </td> <td> <p>EPS Growth With Buyback</p> </td> <td> <p>EPS Growth Without Buyback</p> </td> <td> <p>Total Share Gain Over The Period</p> </td> <td> <p>Total Dividends Over The Period</p> </td> <td> <p>Total Shareholder Return</p> </td> </tr> <tr> <td> <p><strong>Intel</strong> <span class="ticker" data-id="204036">(NASDAQ: <a href="">INTC</a>)</span></p> </td> <td> <p>2012 9month $4 Billion</p> </td> <td> <p>144,000,000</p> </td> <td> <p>-3%</p> </td> <td> <p>-12%</p> </td> <td> <p>-1.4%</p> </td> <td> <p>$1.1</p> </td> <td> <p>3.3%</p> </td> </tr> <tr> <td> <p><strong>HP</strong> <span class="ticker" data-id="203900">(NYSE: <a href="">HPQ</a>)</span></p> </td> <td> <p>2011 $5.6billion</p> </td> <td> <p>244,000,000</p> </td> <td> <p>-10.8%</p> </td> <td> <p>-19%</p> </td> <td> <p>-45%</p> </td> <td> <p>$0.4</p> </td> <td> <p>-39%</p> </td> </tr> <tr> <td> <p><strong>Disney </strong><span class="ticker" data-id="203310">(NYSE: <a href="">DIS</a>)</span></p> </td> <td> <p><span>$16 billion buyback 2010</span></p> </td> <td> <p>39,000,000</p> </td> <td> <p>24%</p> </td> <td> <p>22%</p> </td> <td> <p>23%</p> </td> <td> <p>$0.4</p> </td> <td> <p>24.4%</p> </td> </tr> </tbody> </table>

Intel is forecast to spend $4 Billion on share buybacks this year.  Currently this will account for over 90 % of operating cash flow (net operating cash flow - net financing cash flow). This figure does not include the pay-out of dividends! Intel is paying out 180% of its free cash flow including dividends to shareholders at a time when it is losing market share to competitors and seeing falling revenues.

HP’s story is exactly the same – HP had an operating cash flow of $13 billion and a investing cash flow of -$14 billion resulting in a -$1 billion cash flow with which to return to shareholders. The company then borrowed money to finance its share buyback whilst also borrowing to finance the dividend. At the same time the company’s return on equity fell from just over 20% to 17.5%. A classic case of buying back shares when the company should be investing within itself.

Walt Disney produced EPS growth of 22% in 2010 before the effect of share buybacks and share buybacks only increased EPS by 2%. I think in this case the company would have done better to return cash to shareholders through another method - for instance dividends. Total dividends for the period only amounted to less than an extra 1.4% gain for shareholders.

In essence all of these companies are using shareholder cash for very poorly thought out buybacks. It would be much better to use the cash to improve shareholder returns in other ways. 


<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Total Buyback</p> </td> <td> <p>Total Shares Brought Back</p> </td> <td> <p>EPS Growth With Buyback</p> </td> <td> <p>EPS Growth Without Buyback</p> </td> <td> <p>Total Share Gain Over The Period</p> </td> <td> <p>Total Dividends Over The Period</p> </td> <td> <p>Total Shareholder Return</p> </td> </tr> <tr> <td> <p><strong>Philip Morris</strong> <span class="ticker" data-id="210565">(NYSE: <a href="">PM</a>)</span></p> </td> <td> <p>2011 $8.4 billion</p> </td> <td> <p>80,500,000</p> </td> <td> <p>24%</p> </td> <td> <p>17%</p> </td> <td> <p>30%</p> </td> <td> <p>$3.5</p> </td> <td> <p>36.4%</p> </td> </tr> </tbody> </table>

 Philip Morris presents the positive side for share buybacks. In an industry with declining volumes, tobacco companies are putting their huge free cash flows to good use and are buying back stock, forcing up earnings and share prices. In the tobacco industry a huge amount of capital is not needed for reinvestment and there is a significant margin generated from sales.  In fact the majority of the tobacco industry does not need to rely on buybacks to improve earnings, price increases usually rule out declining sales volumes. However, with Philip Morris currently providing a dividend that increases total shareholder return over the year by around 20% the best way to use the rest of the free cash flow is to buy back stock.

A Well Managed Return

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Total spent on buyback U\SD millions</p> </td> <td> <p>Total shares brought back</p> </td> <td> <p>EPS growth with Buyback</p> </td> <td> <p>EPS growth without buyback</p> </td> <td> <p>Total share gain over the period</p> </td> <td> <p>Total Dividends Over The Period</p> </td> <td> <p>Total Shareholder Return</p> </td> </tr> <tr> <td> <p><strong>International Business Machines</strong>  <span class="ticker" data-id="203983">(NYSE: <a href="">IBM</a>)</span>,</p> </td> <td> <p>$10billion 2010</p> </td> <td> <p>73,000,000</p> </td> <td> <p>13%</p> </td> <td> <p>6.7%</p> </td> <td> <p>23%</p> </td> <td> <p>$2.5</p> </td> <td> <p>25%</p> </td> </tr> </tbody> </table>

 Of all the companies I have looked at IBM seems to have the right balance. The $10 billion share buyback in 2010 managed to roughly double EPS growth for shareholders. Meanwhile dividends paid out to shareholders increased their total return by 2% or roughly a 9% increase. So overall the group has really rewarded its shareholders through both increases in EPS driving up the share price and a well thought out dividend.


Like every company, every buyback if different. However, it pays to research the company and its buyback history. As I have shown above, not every buyback is worth the shareholders hard earned cash. It pays to research if the company is using its cash well or just throwing it away because a share buyback sounds impressive.



RupertHargreav has no position in any stocks mentioned. The Motley Fool recommends Intel and Walt Disney. The Motley Fool owns shares of Intel, International Business Machines., and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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