Image source: Flickr user BagoGames
In 2012, Nvidia (NVDA 2.13%) began a capital return program. This program intended to return cash to shareholders through regular dividends and share repurchases. In November 2012, Nvidia announced its first quarterly dividend of $0.075 per share. Based on the closing price on the day of the announcement, this represented an annual dividend yield of 2.4% -- a healthy yield for a nimble, relatively small, tech company with above average growth prospects.
In 2013, Nvidia began repurchasing significant amounts of its own stock. The effect of Nvidia's share repurchases can be seen in the growth of earnings per share (EPS). When a company repurchases, or buys back, its own shares, the number of shares is reduced. This, in effect, increases EPS as net income is divided by fewer shares.
From fiscal 2013 through the end of fiscal 2016, Nvidia reduced shares outstanding from 624 million to 569 million, or 8.8%. Over the same period, net income increased $562 million to $614 million, or 9.2%. But earnings per share increased $0.90 to $1.08, or 20%, thanks to a lower share count.
Taking advantage of being undervalued
What is particularly noteworthy about Nvidia's share repurchases is that Nvidia purchased less shares as the stock price climbed to higher levels. In fiscal 2014 (or calendar year 2013), Nvidia repurchased $887 million worth of stock. In fiscal 2015, Nvidia repurchased $814 million. Beginning in fiscal 2016, that figure dropped to $587 million. Nvidia repurchased more stock at lower valuation levels and less stock as its valuation increased.
When Nvidia began its capital return program in November 2012, the stock was trading around $12.50 per share. Nvidia repurchased more than $1 billion worth of shares through January 2015 with the stock trading below $20 for most of that time. Nearly all of those share repurchases were made at a price-to-earnings ratio (P/E) of less than 20, a valuation many investors consider attractive for a business with above average growth prospects.
Nvidia also used share repurchases to offset share dilution, as Fool writer Timothy Green discussed. The use of repurchases to offset share dilution from stock options and other equity awards is common practice, and though some investors feel this is wasteful, stock options are an essential tool in attracting top talent in technology.
Whatever the motivation, the opportunism and foresight of Nvidia's management with the timing of share repurchases shouldn't be overlooked.
When Nvidia announced it would return $1 billion to shareholders in 2013, its stock was trading for a P/E of 14 -- meaning investors were paying only $14 for every $1 in earnings. Since then, the stock has seen a seven-fold increase. It's clear that investors in 2013 were not adequately valuing Nvidia's stock price, management had the foresight to realize this and were shrewd enough to repurchase shares when the stock is undervalued.
The company began repurchases as it was finding tremendous momentum and opportunity to leverage its GPUs across different industries. Many growth opportunities have emerged in datacenters and automotive since 2013, and the company's capital allocation plan suggested management foresaw this growth.
When Nvidia announced an expansion of the capital return program, in April 2013, CEO Jen-Hsun Huang stated as a reason: "NVIDIA's strategies are gaining traction in the market and make us confident in our ability to continue generating cash". This statement underlines that the repurchases were an effort to capitalize on what management saw as an undervalued stock price.
Taking advantage of a strong balance sheet
Because of the intense competition in the technology sector, it's important for tech companies to keep plenty of cash on the balance sheet. Yet, it's remarkable that Nvidia -- a company with a fraction of the revenues and cash flows of competitors like Intel and Qualcomm -- distributed to shareholders via share repurchases and dividends approximately 100% of its free cash flow between fiscal year 2013 and fiscal 2016.
Nvidia borrowed about $1.5 billion at an interest rate of only 1% to help finance share repurchases. The company had more than $4 billion of cash on its balance sheet which more than offset this debt, so it wasn't hurting itself financially. Because of its annual cash flow of approximately $1 billion and the $4 billion of cash on the balance sheet, Nvidia had enough to eventually pay down the debt and invest in its core business -- developing graphics processors -- as well as in initiatives like self-driving cars, machine learning, and artificial intelligence. These pursuits have ultimately helped to fuel the company's rapid rise over the last few years.
These investments were made while keeping the balance sheet cash-rich with $6.7 billion in cash and marketable securities at the end of the most recent quarter, and only $1.9 billion in long term debt.
A company that can distribute 100% of its free cash flow, keep a sound balance sheet, and deliver significant capital appreciation in the face of intense competition ultimately indicates a very strong business.
