Restaurant operator Yum! Brands (NYSE:YUM) announced last week that it was authorizing a $1 billion buyback of its shares. With its stock recovering from its latest food scandal in China the share repurchase is a sign the owner of Taco Ball, KFC, and Pizza Hut is bullish on the future. However, should investors be worried that their company is wasting precious capital at a time that it should be investing elsewhere?

Photo: Flickr via Mike Mozart

Yum! Brands buys big. Two years ago it authorized a similar $1 billion buyback and as if that were not enough it authorized an additional $750 million just a year ago. There's still $236 million remaining on that authorization and the current program will be in addition to that amount that's left over.

Clearly Yum! Brands management likes buying back its own shares.


Image: Yum! Brands investor presentation

Yet over the last two years, Yum! Brand's stock has essentially gone nowhere. It's up just 3% over that time frame which compares poorly to a 47% increase for the S&P 500 index. Net income has fallen nearly 9% and earnings per share are down 5%, benefiting from the reduced share count. Last month it cut its full-year guidance for earnings because of the food scandal involving one of its suppliers in China. It generates 35% 
Hey big spender!
So is throwing another $1 billion into reducing its share count further a good use of shareholder resources?
In spite of the stock performance over the last couple of years  Yum! Brands has consistently  worked to return value to shareholders. For example, in September it declared an 11% hike in its dividend, raising the payout from $0.37 to $0.41 per share. 
Yum! Brands has increased the dividend at a double-digit percentage rate every year since it initiated the payout in 2004. Over the past five years it has returned over $6 billion of cash to shareholders through the combination of share repurchases and dividends. 

YUM Dividends Paid (TTM) Chart

YUM Dividends Paid (TTM) data by YCharts

It targets a long-term dividend payout ratio of between 35% to 40%, and it currently sits at 46%. Although higher than Yum! Brands wants, it also suggests the dividend is in no danger of being cut and even has room to grow. And unlike some other  companies that borrow money to buy their stock back, Yum! Brands finances its repurchase programs out of its cash flow. 

Investing in the future
But is all this spending going in the right direction? It generated $2.1 billion in cash in 2013, down almost 10% from the year before. And after reinvesting over $1 billion in capital improvements, and spending $615 million returning cash in the form of dividends, it spent $770 million on buybacks.

Building out more restaurants depends on location. Over the past few years existing restaurants haven't been generating a great deal of same store sales growth, particularly in the U.S., so that is most likely not the best use of capital.

Slip-sliding away. Stores are realizing less repeat business than they were just a few years ago. Data: Yum! Brands quarterly SEC filings.

Greater global focus
Overseas, though, management says the new units it builds, even in the face of falling sales, still exceeds its internal return hurdle rates, so it has no intention of slowing down the build out of international units. That might be a better use of its money.

Rumors are floating it wants to spin off its Taco Bell chain to invest more overseas. The Mexican food chain is the only one with a negligible international presence so it doesn't quite fit in with KFC and Pizza Hut. 
KFC in China already generates 91% of Yum! Brands operating profits outside of the U.S. With only two restaurants per million people in China and India (compared to 60 in the U.S.) there remains room for expansion.

Pay me now or pay me later
And investors ought to keep an eye on the role executive compensation plays in its push for share buybacks. In many ways it's tied to earnings per share, and reducing the share count artificially inflates EPS.

For example, CEO David Novak's direct compensation -- a combination of base salary, annual bonus, and long-term incentives -- is tied to earnings-per-share growth, which Yum! Brands says is its primary performance metric.
In 2013, Yum! Brands' EPS fell 9% last year against a target of 10% growth. Novak's cash compensation decreased 60% in 2013 because his annual bonus took an 80% cut as a result of the under-performance, but his total compensation was down just 26% overall. He still received 41% of his target bonus, or almost $940,000, because of his "individual performance" and a "team factor." 
However, with average diluted shares outstanding declining only 2.5% in 2013 from the prior year, compensation doesn't appear to be driving the agenda, but remains an area to monitor for how it might influence buyback decisions.
Money well spent
Investors look to executives to make investments in the long-term interests of the company. Yum! Brands and other companies insist these compensation practices align management's interest with those of shareholders and are "at risk" just like outside investors.
Thus far it looks like management has been a good shepherd of shareholder resources, and until the buybacks come at the expense of investment in the restaurant's productive capabilities, this $1 billion share repurchase authorization looks like it is money well spent.

Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.