Good stock repurchase programs are rare

Companies have various possibilities to “reward” their shareholders besides delivering strong and growing profits which are commonly referred to as “good earnings quality”. The two most commonly used ways to allocate capital towards stock investors are usually made

  • in form of cash payouts to shareholders (dividends) and/or
  • by repurchasing own stocks which then are cancelled or held as treasury stocks (these can be used for instance to pay for acquisitions).

Buying back own stocks and withdraw them from the market in principle has several positive effects:

  • first, a lower share count has an increasing effect on earnings per shares and
  • furthermore usually boosts the stock price.
  • A reduced share count can also be beneficial to the dividend payout ratio as the total shareholder distribution can be lowered (dividends are paid per stock, when there are fewer shares, the total dividend amount is lowered).
  • Share Repurchase Programs signals owner’s/management’s confidence in the strength and future success of the company.

Capital is a scarce resource and there are various allocation options. And here, being personally a strong proponent of Share Repurchase Programs, I have to say, that all too many companies have them neither well-timed nor effectively executed.

Just look at oil supermajors ExxonMobil and Chevron. In 2011, on the back of oil price at USD 100 per barrel and huge cash flows, these commodity behemoths invested heavily in projects all around the world, signaled their commitment to a progressive dividend policy and each of the two launched a gigantic share repurchase program. ExxonMobil’s stock price at that time was at an all-time high of almost USD 100. Today, ten years later, with an oil price that on average was in a range of USD 50, the stock price sits at around USD 60. ExxonMobil stopped its share repurchase program when oil prices came down instead of taking advantage of a lower stock price.

It’s all too often the same procedure. When things are good, cash is flowing in, companies launch generous Share Repurchase Programs during which stocks are not seldomly bought at all-time highs. And then, when things are tough, these programs are abruptly stopped, although there would be tremendous opportunities to buy back their own stocks on the cheap which would make their capital allocation extremely efficient.

Cyclical, capital intense companies should in my be very careful with Stock Repurchase Programs. They better used these funds to pay down debt, invest in Research and Development, or used cash to make company acquisitions.

There are of course some businesses that had for years very successful Share Repurchase Programs, such as Disney, Facebook, Johnson & Johnson, and of course Alphabet.

In April 2021, Alphabet announced a USD 50 Bn Share Repurchase Program which followed a USD 25 buyback program announced in 2019.

Now, to what extent is Alphabet’s situation different from ExxonMobile’s in 2011?

First, Alphabet’s net cash position sits at USD 100 Bn. ExxonMobil was a triple. A company but never had such a cash pile and instead of increasing debts. ExxonMobile has committed funds to several oil projects around the world in the amount of tens of billions each year.

And there is another huge difference: ExxonMobil’s cash generation depending on one huge factor they cannot have an influence on the oil price. Alphabet in contrast has multiple ways to increase their revenues, they are highly innovative.

At first sight, Alphabet is sinking billions of dollars into their stocks which are running from one all-time high to another. But don’t be mistaken: Alphabet stock’s price development lags constantly improving fundamentals. In fact, profits are growing faster than their stock price.

I’d even say: Alphabet is executing a Share Repurchase Program on a more or less constantly undervalued stock. And here comes the beauty of the Compound Effect to play.

Alphabet has the ability to increase profits comfortably by more than 20 %. Each year!

Now throw in the repurchase of own shares for several billion each year into the equation and you can see, the effect is gigantic.

Yes, Alphabet is a one trillion market cap company, so “a few billions” in share repurchase per year don’t seem a lot. But add that effect to organic growth of at least 20 % and you easily come to a 25 % Earnings Per Share (EPS) growth. Year by year.

Now, let’s take a calculator and start with USD 100 which can easily be expected EPS for 2021 (which puts the Price Earnings Ratio to roughly 25). Let’s say that USD 100 EPS grows at 25 % year by year. Just extrapolate to 2031, ten years from now. There is an astonishing number, showing an EPS of over 700! A seven-fold increase. Just ten years from now.

We all know, that over the long run, a stock market is a weighing machine, to quote Warren Buffet and Benjamin Graham. Alphabet’s stock price will follow the EPS trajectory over time.

You can see, even under extremely conservative assumptions, good Share Repurchase Programs can help to build huge wealth. It requires of course one thing to be a life-changing factor for investors: there must be a high-quality company with a durable economic moat.

Such wonderful are rare.

And unfortunately, good Repurchase Programs are even more scarce.

Disclaimer
You are responsible for your own investment and financial decisions. This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.

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