These Companies Grow Shareholder Value Better Than All Others

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

There are two primary ways companies grow value per share: (1) increasing the value of operations, and (2) decreasing the share count over time through repurchases at prices at or below intrinsic value. Companies that do either one of these tend to outperform the market over a long period of time. However, companies that increase the value of the business and decrease the share count tend to do the best.

Lucky for us, there is a small but growing contingent of growing companies that habitually lower shares outstanding by a significant amount over time. The three highlighted below are Advance Auto Parts (NYSE: AAP), International Business Machines (NYSE: IBM), and McDonald's (NYSE: MCD). Each company continues to lower its share count and has bright future prospects. As a result, investors may expect higher returns from these companies than their price-to-earnings ratios indicate.

Cannibals

The chart below shows the shares outstanding for each company over the last ten years. IBM and McDonald's are charted using the left axis, while Advance Auto Parts is charted on the right axis.



All three companies have steadily repurchased shares regardless of price or market environment. Although this is not the most efficient, or even shareholder-friendly, method of share repurchases (shareholders would prefer them to purchase a large amount of shares only when the stock price is below intrinsic value) the repurchases average out to a net benefit to shareholders.

By the end of the decade, shareholders will own significantly more of these companies than they originally paid for. Even if McDonald's stopped growing, value per share would still increase due to share repurchases. However, when combined with growth in the value of operations, share repurchases compound the increase in shareholder value.

Improving operations

The reason that constant share repurchases average out to a net benefit for each of these companies is that their operations are growing, not deteriorating. Although it is still possible that the shares are overvalued, the growth in the value of operations will eventually negate value-destroying repurchases.

Over the last decade, all three companies have grown free cash flow by a meaningful amount -- and earnings by an even higher amount.



The exact amount of growth is not as important as the fact that the number is growing. Advance Auto Parts, IBM, and McDonald's are all improving, not deteriorating.

  • Advance Auto Parts is already the most efficient auto parts supplier in the do-it-yourself market, and it has significant growth opportunities in the commercial market.
  • IBM is long past its high-growth days, but its customer relationships are so deep that it is virtually assured to continue increasing cash flows for the foreseeable future.
  • McDonald's is the leading fast food chain with the most recognizable name in the industry; its growth prospects in China make it likely that profits will continue to grow at a steady clip over the next decade.

Compounding value per share

When taken together, free cash flow growth and share repurchases compound shareholder value at a high rate. Each company has increased its free cash flow per share by a significant amount as a direct result of share repurchases. As a result, these companies are worth far more than they would be had management simply paid out the cash in a dividend.

Bottom line

Constant share repurchases are nearly always good for shareholders. When combined with growing earnings, share repurchases compound shareholder value at a much higher rate than could otherwise be achieved. Therefore, investors who buy growing companies that habitually repurchase shares -- and hold on for the long run -- will likely be rewarded by outsized returns.

If you're an investor who prefers returns to rhetoric, you'll want to read The Motley Fool's new free report "5 Dividend Myths... Busted!" In it, you'll learn which stocks provide premium growth and whether bigger dividends are better. Click here to keep reading.

 


Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends McDonald's. The Motley Fool owns shares of International Business Machines. and McDonald's. 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!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure