Dividends have long held a special place in the hearts of investors. I believe it was John D. Rockefeller who once proclaimed that the only thing that truly gave him pleasure was to "see his dividends coming in." While I can attest to the satisfaction derived from seeing the quarterly dividend checks hitting the brokerage statement, the dividend isn't the only way that companies return cash to investors.
Share buybacks are another means to use cash to benefit shareholders and, when used appropriately, can radically increase stockholder wealth. I found a great example of this in Utah Medical Products (NASDAQ:UTMD), about which I wrote last year to demonstrate the power of share buybacks. Utah Medical makes for a perfect case study, because it increased earnings per share by 124% from 1997 to 2001 on an 11% cumulative increase in revenues, primarily by buying back boatloads of stock.
Anyway, this got me thinking about the perception of dividends vs. stock buybacks in the minds of investors. While both are methods of returning cash to shareholders, the effect of dividends is much easier to measure -- the cash is right there to see. Dividends also tend to be issued quarterly, and the amounts are generally predetermined and therefore reliable. If you look up a stock on the Internet or in the newspaper, you'll see right away that it pays a 3% dividend, or whatever it may be.
In contrast to dividends, share buybacks aren't declared every quarter, there's no equivalent to the dividend yield when it comes to buybacks, and, in any case, repurchase activity tends to be irregular from quarter to quarter and year to year. If Utah Medical had paid out in dividends the $65 million it spent on share repurchases from 1997 to 2001, I bet more investors would have been attracted to the stock's high dividend yield, but I doubt shareholders would be nearly as well-off today.
Introducing the "share buyback yield"
Let me throw a new concept at you. Suppose we could calculate the "share buyback yield" for a given company implied by its buyback activities. This would allow us to compare the yields offered by companies that choose to pay dividends with companies that prefer to buy back stock.
The easiest and most obvious way to compute a share buyback yield for a given company is to compare the number of shares outstanding from year to year to get the percentage change. As an example, let me use Lone Star Steakhouse (NASDAQ:STAR), a company that I introduced to readers in our Motley Fool Select (now Motley Fool Hidden Gems). Lone Star has been on a massive share buyback spree for several years and has reduced the total number of shares outstanding from over 41 million in 1997 to about half that today. Let's take a look:
Lone Star Steakhouse
Shares Outstanding 1998-2003Date Shares Out Change3/10/1998 41,179,263 n/a 3/23/1999 35,812,766 -13.0% 3/21/2000 26,887,952 -24.9% 3/19/2001 24,031,614 -10.7% 3/19/2002 24,333,233 + 1.3% 3/10/2003 21,263,052 -12.6%
One could argue that Lone Star paid out a share buyback "yield" to shareholders of 13% in 1999, 24.9% in 2000, 10.7% in 2001, negative 1.3% in 2002 (when shares outstanding increased), and then 12.6% in 2003. Averaged over those five years, Lone Star returned about 11.6% per year to shareholders simply by repurchasing shares. That's one way to look at share buyback yield (and, by the way, Lone Star also pays out a very respectable 3% annual dividend).
Another possibility is to use the weighted shares outstanding as used in the earnings-per-share calculation. Using this method, we would get the results below:
Lone Star Steakhouse
Wtd. Avg. Shares 1997-2002Year Shares Change1997 41,013,749 n/a 1998 39,989,091 -2.5%1999 35,089,084 -12.3%2000 26,189,600 -25.4%2001 24,036,942 - 8.2%2002 22,908,821 - 4.7%
Using weighted average shares gets us to about the same place, with an average share buyback yield of 10.6% per year over the five years from 1998-2002.
Other fun stuff
Of the two methods above, I prefer the weighted average shares approach, because you can use it in conjunction with the cash flow statement in the annual report to come up with some fun and interesting information. For example, using Lone Star's cash flow statement, I was able to figure out how much cash flow per share the company has generated, and how much of that cash per share was used for dividends and share buybacks each year. (For buybacks per share, I take cash used for stock repurchases and subtract any cash received for issuance of stock.)
Lone Star Steakhouse Dividends and Buybacks Per ShareYear FCF/ Dividends/ Buyback/ Share Share Share 2002 $3.19 $0.60 $3.722001 $2.89 $0.50 $0.132000 $1.04 $0.38 $1.871999 $1.05 $0.00 $2.18
As you can see, over the past four years, Lone Star has produced over $8 per share in free cash flow, paid out $1.48 per share in dividends, and spent $7.90 per share to buy back stock. As you might imagine, its shareholders have made out like bandits over the last four years, with the stock up from a low of about $6 in January 1999 to its current $22.
I'm hoping to explore the concept of share buyback yield more in my next article. In the meantime, if you think up a better mousetrap or just have suggestions on how to make the share buyback yield a more useful metric, please feel free to e-mail me with your comments.
Zeke Ashton, a longtime contributor to The Motley Fool, is the managing partner of Centaur Capital Partners, LP, a money management firm in Dallas, Texas. He has a position in Lone Star Steakhouse and Utah Medical Products. Please send your feedback to [email protected].
