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How Microsoft Won the Buyback Game

By Motley Fool Staff - Apr 22, 2016 at 9:00PM

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The company's mid-2000s buybacks are a shining example of what capital allocation should be.

Buyback programs, when timed right, can supercharge a company's returns. By reducing the outstanding share count, they increase the portion of earnings that each remaining share of stock is entitled to.

In this clip from Industry Focus: Tech, Sean O'Reilly and Dylan Lewis talk about Microsoft's (MSFT 1.82%) beautifully executed buybacks during the 2000s, and how they accomplished everything a buyback should. The two look at the company's timing, exactly how it executed the share purchases, and the impact it had on the Redmond giant.

A full transcript follows the video.

This podcast was recorded on April 15, 2016. 

Sean O'Reilly: Yeah, and actually, that's a great segue to the company that I wanted to highlight, which is Microsoft. They have arguably had a monopoly since the late '80s. (laughs) Like, 90% market share the entire time, of the PC market, probably higher. They didn't start paying out a dividend until 2003.

As I'm going to point out in a second here more in depth, they didn't really start buying back shares in earnest until the mid-2000s. They bought back a few, I think we looked earlier, it was like a couple hundred million dollars, in the '90s. And that was clearly just to take care of the dilution from all the options they were giving employees. They have a monopoly, they're generating billions of dollars in free cash flow, and they didn't even do what GoPro did until way later. I mean, that's just ...


Dylan Lewis: It's baffling.

O'Reilly: Guys, what are you doing?

Lewis: So, what else do you have, in terms of Microsoft's strengths in capital allocation?

O'Reilly: So, bringing it around, what I wanted our listeners to know was, most of us probably know, Microsoft shares have kind of languished a little since the bubble popped in 2000. The stock was at huge multiples, and they didn't really go anywhere until very recently, until Ballmer stepped down and they got the new CEO, Nadella.

After the bubble popped, they bought back anywhere from 3 to 6.5 billion worth of shares in 2001 and 2005. The stock kept languishing, so they were like, "We're making more and more money every year." Profits went from $7 billion in 2001, they were $12 billion in 2005, they kept growing over $20 billion by the early 2010s. So, the business is doing fine this whole time, but the shares just aren't going anywhere. So, clearly, as responsible capital allocators, they're going to be like, "Maybe we should buy back some shares."

Lewis: Yeah, let's slice this pie a few less times.

O'Reilly: Exactly. That's what they started doing in 2005, in a big way. In 2005, they bought back $8 billion shares. In 2006, $19 billion. 2007, $27 billion, and all of this is after paying that $32 billion special dividend in 2003. It's really funny to see huge $2-3-4 --

Lewis: Boop!

O'Reilly: Yeah, it's like boom. $12 billion in 2008 and 2009, $11 billion in 2010, and this whole time, at the depths of the Great Recession, the year when Microsoft bought back $9 billion worth of shares, and the previous year they'd bought back $17 billion, the P/E on Microsoft got as low as 9. [These are] crazy awesome purchases that they are making. The stock went from the mid-teens, it touched bottom in 2009 at $15 per share. All those repurchases were made over the last 10 years, and now Microsoft is at $55. That is awesome!

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