Amazon's (AMZN 1.66%) board has faith in where the company's stock is headed -- at least based on the company's new repurchase program. On Wednesday, the e-commerce company surprised investors when it announced its board more than doubled the authorized amount available for share buybacks, suggesting the board believes the stock may look more enticing after pulling back from $675 at the beginning of the year, to $504. Shares ended the day following this announcement up nearly 3%.
Here's what investors need to know.
The program
Until Wednesday, Amazon's management was operating under the stipulations of its previous buyback program. For the previous program, which was first authorized in 2010, the company could repurchase up to $2 billion worth of shares.
Notably, Amazon had only utilized $1.24 billion of its purchase program by the end of 2015, so it's easy to see why the announcement may have taken investors by surprise. With more than a third of the currently authorized program left to spend, the seemingly early timing of an expansion to the program suggests the board may feel now is an opportunistic time to repurchase shares.
The new authorization for buybacks, at $5 billion, is significantly larger.
"The program allows the Company to repurchase its shares opportunistically from time to time when it believes that doing so would enhance long-term shareholder value," said a company 8-K filing. The new program "does not have a fixed expiration," the release noted.
The stock
With a boost to the company's buyback program, it's a good time to take a look at the stock's valuation and the underlying business to see whether repurchases would truly enhance long-term shareholder value at this point. Trading at $504 at the time of this writing, shares are about 28% off of an all-time high. Any repurchases at these levels would get shares at a discount compared to where they were trading previously.
But investors should keep in mind that this discounted stock price still prices in considerable growth. The stock currently has a price-to-earnings ratio of about 400, representative of the company's ruthless spending on expansion. Even Amazon's price-to-sales ratio is hard to justify. Trading at 2.2 times sales, the company trades at about three times the average price-to-sales ratio of industry peers.
If there's any business that should trade with a very forward-looking valuation, it's Amazon. The company has proven to investors it can grow its business consistently while also improving operations as it scales. And in 2015, in particular, the e-commerce company teased investors with what could be ahead for the growth of the business. During the year, Amazon's operating income leaped from $178 million to $2.2 billion, and free cash flow soared 276%.
Overall, the board's approval of a larger repurchase program makes sense. Not only are shares trading lower, but management also proved to the board in 2015 that the company can turn up the volume on its profits while simultaneously growing with the same tenacity as it has in years past.
