What Does Ford Motor Company's Share Buyback Mean for Investors?

Ford's share buyback announcement looks good at first glance, but is it really all what it's cracked up to be?

May 15, 2014 at 1:31PM

On May 7, Ford (NYSE:F) announced that it will buyback 116 million shares, or roughly $1.8 billion worth of stock. The move is intended to offset the effects of senior convertible notes that are due in 2016, as well as the employee stock-based compensation for this year. 

While at first this looks like great news, it's sort of a non-event. On paper, buybacks always look good to shareholders. 

A company is buying millions of shares in the open market and retiring them. The resulting effect boosts earnings per share, lowers the share count (theoretically making each share worth more money), and results in fewer shares to pay a dividend to. 

In Ford's case, shareholders will benefit from all three effects. 

Below the surface
However, the one caveat is this: The company is doing it to offset the effects of convertible debt and stock-based employee compensation. 

In other words, the company is only buying in roughly the amount of shares that will be issued to employees and come to the open market via senior debt (convertible bonds) that will convert into shares at a specified price. 

This is not the first time Ford has offset such dilutive effects, and Bob Shanks, executive vice president and CFO had this to say about it: "These actions are consistent with our overall capital strategy to take anti-dilutive actions and position ourselves to further reduce Automotive debt." 

Of course, the news of the buyback does look good, and as a shareholder, I won't complain about the 2.5% one-day jump the stock received on the news. Nor will I complain about the approximately 3% float reduction that will result in the company's share repurchase. 

At least more shares aren't coming onto the market, which would be the case if Ford chose not to do the buyback. The resulting effect of the buyback will leave Ford's outstanding share count slightly below 4 billion.

A look at its main competitor
With a dividend yield north of 3%, I am pleased with management's return of capital to shareholders. They have overseen a faster recovery at Ford than management at General Motors (NYSE:GM), which had announced its dividend in mid-January. 

Although General Motors does have a higher yield -- 3.5% versus 3.2% -- it's only because the stock has fallen 14% since the announcement of its dividend. Shares of Ford on the other hand, have fallen less than 2% in the same time frame. 

Currently, neither company has a driven focus on buying back more shares. At least, not in the form of putting its money where its mouth is.  

Buybacks over dividends?
I am quite comfortable with Ford's $0.125 quarterly dividend payment, ($0.50 annual payout). This equates to a payout ratio of just 27%.

For those of you that are not familiar with the payout ratio, it is a measurement of how much a company pays out in dividends, relative to its earnings per share. The lower the percentage, the healthier the payout is, generally speaking. I look for companies with a payout ratio below 50%, so Ford's 27% payout is quite reassuring. 

And because of this, I know that the company can afford to return even more cash to shareholders. But I'm not looking for it to be in the form of dividends. 

With an annual dividend of $0.50, Ford will shell out roughly $2 billion in cash to shareholders this year. Instead of boosting this figure, what if Ford announced a conservative buyback of $1 billion-$2 billion? 

Meeting in the middle with a $1.5 billion share buyback program, Ford would retire 93,750,000 million shares based on an average share price of $16.

While that may seem like a lot of shares to you or me, it equates to less than 2.5% of outstanding shares. Ford could always do more, especially with the strength on its balance sheet. From the press release (linked above): "The company ended the first quarter with Automotive gross cash of $25.2 billion, exceeding debt by $9.5 billion, along with a strong Automotive liquidity position of $36.6 billion."

Final thoughts
Just because Ford could implement an egregious, over-the-top buyback program to please investors, doesn't mean that it has to. 

The dividend yield, strong auto market, and earnings per share story are all positive catalysts. But seeing some shares come out of the open market boosts the share price, earnings per share, and investor sentiment. which shows investors that management is confident enough in tomorrow's business to buy shares at today's prices.

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Bret Kenwell owns shares of Ford. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. 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.

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