Time was when a share-repurchase announcement meant one of two things. Either the company truly believed its share price was undervalued (signaling a time to buy for the rest of us), or the company was making a desperate attempt to prop up its share price (signaling a good time for shareholders to get out of Dodge).
Now it seems as though the majority of companies have some kind of share repurchase program. According to Standard & Poor's, share repurchases by S&P500 firms totaled $197 billion in 2004, up 51% from 2003. Despite that, S&P said those companies were still sitting on $619 billion in cash at the end of 2004, so don't look for the buyback momentum to slow anytime soon.
Now, I'm not opposed to this. Companies that have cash flow outstripping attractive investment opportunities need to manage that cash flow in a way that benefits shareholders. Investment bankers call this "capital structure management," and when you dig into the subject, it's hard to argue against share repurchase as an intelligent way to go. It's far more flexible than big dividend increases, which might not be sustainable if the company experiences a downturn. They also (at least in theory) should add to shareholder value through an acceleration of EPS, translating into higher share prices for the remaining stockholders. Finally, they don't have the tax consequences for shareholders that a dividend has.
But my interest these days as a value-seeker lies not in capital structure, a rather dry subject under the best of circumstances. I find it far more interesting to try to figure out what a share repurchase program can tell us about a company and its prospects as a solid future investment. A little research and some intuition can uncover a lot. Here are a few cases in point, some of which are pretty revealing.
Autozone (NYSE:AZO) has grown its sales about 2.5% annually for the past two years. During that time, they've invested $367 million in capital expenditures (opening roughly 200 stores while spending over $1.6 billion to buy back shares). The stock has moved slightly higher, but nothing to write home about. Conclusion: Limited growth options. While the company may be managing its capital structure very effectively, it's not a stock that fits my growth-company mentality. I personally wouldn't buy the shares, although they may fit your investment profile.
Target (NYSE:TGT) announced a huge share-repurchase program last year after receiving close to $5 billion from the sale of Mervyn's and Marshall Field's. The company put the cash to use by calling some debt and announced it intends to buy back $3 billion of shares over the next three years. But Target has not previously had an aggressive share repurchase program. Conclusion: Wise move to give the cash windfall back to shareholders. I especially like that it bought $1.3 billion of shares last year at an average price of $44.68, with the stock currently trading in the mid 50's. Since the company is buying back the shares over a long time horizon, I suspect they might be keeping some of their powder dry for a growth acceleration or acquisition, but that's just speculation. Nevertheless, Target continues to grow at a fairly rapid pace, and I like the way it's rewarding shareholders and keeping options open.
Dell (NASDAQ:DELL) has bought back $6.5 billion worth of shares over the past three years, but the number of outstanding shares has remained flat at 2.6 billion. Conclusion: The company is issuing shares to employees at a very fast pace. The share repurchases are simply to avoid dilution.
Wal-Mart (NYSE:WMT) has been very actively buying back shares for several years, including $5 billion in 2003, followed by $4.5 billion last year. The share base is declining by about 90 million shares a year, so the buybacks are not primarily to avoid dilution. Still, it's interesting that last year the company financed the share repurchase largely by increasing debt close to $4 billion. Adjusted debt to adjusted capitalization rose by over 1%. Conclusion: This level of share repurchase, funded by debt issuance, appears to me like the company is trying to prop up its stock price and doesn't foresee any large acquisitions on the horizon. No doubt company officials would vehemently disagree with that conclusion, and it's true I don't sit in the boardroom. It's also possible Wal-Mart believes its shares are hugely undervalued and is buying the shares back as fast as possible. Time will tell, but The Motley Fool encourages its writers to state their opinion; this is mine. Feel free to draw your own conclusions.
I must admit that Costco (NYSE:COST) is something of a mystery to me. Its board of directors authorized a share repurchase program in 2001. To date, the company has not bought back any shares, although it has built up a war chest of $3.8 billion in cash and short-term investments as of last February. The company has drawn some criticism for this from the street, although my colleague Bill Mann pretty adroitly countered this a few days ago. Conclusion: I see three potential signals here. The first is that the company, which probably has the best buyers in the galaxy, won't repurchase any shares until they think the price is an exceptional value. The second is that Costco is gearing up for another growth push. The third is that the company, which values its customers on a par with shareholders, has some customer-value initiative up its sleeve. Regardless of which of the three is actually the case, I see signals of something interesting about to happen.
Speaking of buying shares back at a value price, I should note here the opinion of Warren Buffett of Berkshire Hathaway (NYSE:BRKA). The most recent pronouncement of his I could find on the topic of share repurchase is from the 1999 annual report, in which he said: "Now, repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price... We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated." Not much doubt where the oracle from Omaha stands, as he ended last year with over $40 billion in cash and equivalents on the balance sheet, just waiting for the right place to invest.
What can we learn from this? I think that even in our current environment, clouded by the smokescreen of capital structure initiatives, there are signals to be found in the way companies decide to execute share repurchase activities. But it takes some research and more than a little intuition to dig them out. So much for the good old days, and happy hunting.
Tom Gardner also pays attention to share repurchases in Motley Fool Hidden Gems . If you enjoy small-cap investing, Hidden Gems might be for you. Consider a free, 30-day trial. There's no obligation to purchase.
For further enlightenment on share repurchase, check out:
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Fool contributor Timothy M. Otte could use some assistance with his personal capital structure. He welcomes comments on his articles and owns shares of Wal-Mart and Berkshire Hathaway.
