Over the last four years, Comcast (NASDAQ:CMCSA) has generated tremendous shareholder value by repurchasing its own shares.
Comcast plans to continue its buyback program by purchasing $2.5 billion of stock in the near future.
Although buybacks may have made sense in the past, the current price of Comcast's stock, coupled with a lack of growth in its pay TV business and increasing competition in the ISP market, makes repurchasing shares a questionable option for Comcast going forward.
The company should consider retiring the buyback program and investing more in its Internet services segment.
Comcast's buyback program
Buybacks, also known as repurchases, can be a great financial policy tool when a company's stock price is undervalued. For example, if a company buys 1,000 of its own shares for $10 a share, and later on those shares rise to $15, $5,000 of shareholder value is created.
Since the beginning of 2010, Comcast's share buyback program has created about $9 billion of shareholder value:
Year to date, Comcast has purchased $1.5 billion of stock and plans to buy at least another $1.5 billion worth before 2015. If shareholders vote in favor of Comcast's acquisition of Time Warner Cable (NYSE:TWC) on October 8th, management will repurchase an additional $2.5 billion of stock.
It may no longer makes sense to buy back shares
Just because buying back in the past created shareholder value doesn't mean it will work in the future. Recently, certain things have changed that make the continuation of the buyback program potentially harmful to shareholders in the future.
Buying back shares only makes sense if the shares are undervalued. If a company buys its own shares, and later the market price for those shares declines, shareholder value will be destroyed and the money for the buyback could have been better distributed to shareholders through a dividend.
Although it's difficult to know the true value of company's shares, it may be safe to say Comcast's shares are anything but undervalued.
First of all, its price to earnings ratio, or P/E, is high. At 19 times trailing earnings, Comcast's P/E is nearly double the P/E of comparable companies such as Verizon and AT&T, and 30% higher than the S&P 500's P/E ratio of roughly 15 times.
Its high P/E doesn't necessarily mean Comcast's shares are grossly overvalued. If Comcast had a high potential for earnings growth, a P/E of 19 times would make sense. But it doesn't.
The pay TV industry is shrinking
The pay TV industry, where Comcast derives 56% of its revenue, is shrinking. For the first time ever, Comcast, and the pay TV industry as a whole, recently lost subscribers, caused by changing technology and demographics. Read about the trend here.
And the potential for earnings growth in its other major business segment, high-speed Internet, is not looking too promising either.
Fiber optic Internet is taking the country by storm. Google, AT&T, and CenturyLink are all bringing their fiber optic Internet services to dozens of new cities. Their services are up to 10 times faster than Comcast's traditional broadband and are available for a comparable price.
And the FCC is attempting to inspire competition in the high-speed Internet market. FCC Chairman, Tom Wheeler has voiced his plan to to get rid of laws that inhibit cities from offering their own high-speed broadband services.
Comcast may soon be forced to upgrade its current infrastructure in many areas including Minneapolis, where CenturyLink will begin offering its Google Fiber-like services in a matter of months. If Comcast fails to make the improvements, it could lose Internet subscribers to companies with more appealing service offerings.
The bottom line is the increasing competition in the ISP market may compromise the high margins Comcast has experienced in its Internet services segment over the past few years. Which is one more reason the company shouldn't have a P/E of 19 times trailing earnings, and buying back shares doesn't seem to make sense.
What Comcast should do instead of buying stock
Rather than purchasing an additional $2.5 billion of stock, Comcast could invest that money into its Internet services business. Specifically, the company could install fiber optic cable to its residential Internet customers in the many areas, such as Minneapolis, where competitors are planning to expand their own superior fiber optic-based services.
That said, as outsiders, there are many motivating factors for capital allocation policies that we don't know about. And it's difficult to be certain what the "right" strategy is. But with the relatively expensive market price of Comcast's stock, numerous factors causing pay TV subscriber losses, and increasingly competitive landscape of the high speed Internet market, it seems buying back shares doesn't make sense for Comcast going forward.
Michael Nielsen has no position in any stocks mentioned. The Motley Fool recommends Google (A shares) and Google (C shares). The Motley Fool owns shares of Google (A shares) and Google (C shares). Try any of our newsletter services free for 30 days. We Motley 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.