My perception is the majority of stock investors do either prefer dividend stocks or something with a high growth component like first and foremost technology. The third group would be turnarounds (which I am also not opposed to). What is much under-appreciated, though, are cannibals or buyback monsters. I think this topic should earn more attention. Good for those who know about it.
Summary and key takeaways from today’s Weekly
– Buybacks seem not to be properly understood – big total numbers are celebrated, but most often indeed only good for bold headlines.
– One should know about how to best conduct buybacks and about the disproportionate effect with a lower share count – the more the way better.
– If done properly, i.e. at low valuations, they can be brutally powerful and rewarding for patient shareholders.
Cannibals are rather associated with horror movies.
In investing lingo, though, cannibals are a good thing and nothing to be afraid about, given that the operating business is doing well or at least going sideways. Just think of companies that are eating themselves alive – they are buying back their own shares.
And lots of it!
Preferably at ultra-low valuations. The more aggressive, the better, because it gets really interesting only at a later stage as I will show below.
Basically, that’s the whole recipe.
However, what reads like a no-brainer, is really hard to find in the market of stocks.
The hard truth to swallow is, many management teams are not good at capital allocation. And even good is not excellent. Almost no one would cut a dividend that has been paid for years or even decades (just think of those useless dividend titles) to aggressively buy back a cheap stock, even if the economics behind it were clearly favoring it.
Shareholders could benefit more, but they don’t.
When finding a good stock with a promising future is one in a hundred, finding a good stock and on top of it with a skilled capital allocator who makes use of distressed prices for the biggest bang for the buck, it becomes another fraction of the whole.
This is pretty hard to find, but it can be really rewarding.
This does not mean that there are no bloody experiences to be made.
There are enough examples of debt-financed and ill-timed repurchases that destroyed lots of shareholder value, only because management wanted to spend somehow the available cash. Those who bought just for the buybacks only to see their stocks drop, know what I’m describing.
What I am talking about today, are those companies which do a great job of cannibalizing themselves. With a lower share count, every single piece becomes more valuable, in case the core business first and foremost continues to generate lots of free cash flow.
Though growth is nice, at an absurdly low valuation growth isn’t even necessary.
With a lower share count and thus a higher value per share, metrics like earnings or cash flows apiece go up. Growth comes on top of it. This force can propel such a stock dramatically higher, allowing for a less risky strategy compared to investing in high growers that can come down to earth quicker than thought.
Buyback monsters or cannibals are a good thing to know about.
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Don’t be blinded by a buyback’s size
When being asked about companies with the biggest buybacks (see for example here), almost everyone will name at least one of the following:
- Apple (ISIN: US0378331005, Ticker: AAPL)
- Meta (ISIN: US30303M1027, Ticker: META)
- Microsoft (ISIN: US5949181045, Ticker: MSFT)
- one of the other big techs
- or maybe Exxon Mobil (ISIN: US30231G1022, Ticker: XOM)
There couldn’t have been a dumber answer, if you’re a sophisticated stock picker.
I am saying this because it is not the absolute or total size that matters, but the economic value that gets created through a buyback for the shareholder.
The commonly known, but obviously not understood “big bang for the buck”.
The numbers these companies throw around of course all do sound impressive at first sight. They’re all having active repurchase programs ranging from 50 to 100 bn. USD. To put this into perspective: that is more than the majority of companies have in total market caps. These are huge numbers, no doubt.
These big fish are spending such sums often in a year or two – on top of all other expenses and also dividends – to buy back their own stock.
However, compared to their market caps, it turns out, that most of the efforts are just cosmetics.
If you do the math, you’ll see that none of them can repurchase more than 5%, not to mention 10% or more of their stock in a single year. That would be impressive and meaningful. I will show you later in this weekly that there are such examples.
The tech stocks above can reach out for somewhere between less than 1% and up to almost 4% of their outstanding stock, because their market caps are so high. Of course on a gross basis, because they have huge stock based compensation packages that dilute shareholders.
Microsoft which has bought back 20 bn. over the last twelve months, is only grabbing less than a percent a year (without mentioning that half of it is needed to offset dilution from stock based compensation which is 10 bn. USD).
Over the last almost five years, their share count has fallen only by 3.7% – after having spent more than 115 bn. USD on buybacks.
Over the last ten years, its –11% net – that’s also just slightly more than a percentage point a year.
Sorry, Microsoft is certainly not a buyback monster!
Exxon is the most attractive in this regard, however, their in total 50 bn. USD program is spread over many years – this is a point that should always be checked, the expected duration of the buyback. On a yearly basis, they are buying back 20 bn. USD of stock. At the current market cap of 480 bn. USD, this is a smidgen above 4% p.a.
Okay, but certainly not impressive.
Personally for me, everything below 5% net in one year is pure cosmetics.
Honestly.
The reason? Well, you need to understand the mathematics behind it. The good news is, it’s neither complicated nor is it unfamiliar, at least to my longer time readers.
I have on several occasions shown the following table in one form or the other in the contexts of either “what needs to be gained back after a loss” (here) or regarding tobacco losing stick volumes and having issues balancing it through price hikes (here).
You see, certain core concepts tend to repeat. 🙂
Here and regarding buybacks, we can use it again.
| share count down by | economic value created |
| –5% | +5.3% |
| –10% | +11.1% |
| –20% | +25% |
| –25% | +33.3% |
| –33.3% | +50% |
| –50% | +100% |
| –80% | +400% |
| –90% | +900% |
I could have filled in more rows, but the core message is the following:
- the more buybacks (read: lower share count, not dollars spent), the disproportionately higher the created value for shareholders
- only after about –25%, the other side of the table starts to gain steam meaningfully
Now you should see the problem I have with those companies shown above.
Reaching anything close to 20–25%, would take them easily a decade (maybe with the exception of Exxon and higher oil prices), if not even two. In the case of Microsoft maybe even close to three at the current valuation…
When talking about buyback monsters, I want to see lots of torque.
Now, let’s look at some real-world examples.
Go for the cannibals
There’s a reason I included the number of –90% in lower share count in the table above. Admittedly, this is really tough to find.
But there’s indeed an example, though an older one that the majority, including me, hasn’t lived while this took place.
I am talking about the legendary, though almost unknown to today’s mass market investors, Henry Singleton, a mathematician and Ph. D. in electrical engineering who was able to play chess blindfolded, and his tenure at Teledyne (ISIN: US8793601050, Ticker: TDY) which he founded.
Teledyne Technologies is still a public company today.
You can see below that the stock is up more than 40x over the last 25 years – Singleton retired already in 1990.
He was such a great capital allocator that he indeed over a timespan of three decades managed to repurchase 90% of his company’s stock.
Self-explanatory, he beat his peers as well as the broader market not just by percentages, but by whole factors. Over 28 years, an investment in Teledyne returned 12x more than an investment in the S&P500 would have (!).
How did he achieve this?
Certainly not by buying back at the highs and doing nothing at the lows – this is what many companies do. Many cannot do better due to their cyclical business and the resulting cash flows. But some definitely could.
Singleton was crazy enough to raise equity without needing it for the underlying business when the valuation was insanely high, e.g. in the early 1970s. Then during the bear market, he aggressively repurchased what he was able to get his hands on.
He did lots of so-called accelerated share repurchase (ASRs), where he offered a premium to the current share price. But instead of buying it slowly over time, he aggressively went for everything available as quickly as possible.
No one does such things today. Imagine Apple announcing a hefty capital raise today (though this example is a bit flawed, as Apple is huge and Teledyne was not THAT big). Apple also does ASRs, but not as aggressive as Singleton did at Teledyne.
This alone was the equivalent of a ten-bagger, because a 90% lower share count increases the economic value tenfold – yes, 10x.
To make it clear, Teledyne was not an organically fast growing fancy biotech business, but an electronics conglomerate.
I hope you see how powerful aggressive buybacks can be over a long period.
If you’re interested in more details and an in-depth write-up, I can recommend to read the book “Outsiders” by William Thorndike. In the respective chapter, there is a chart where the stock was already up by 180x between its foundation and 1990, the year Singleton stepped down. Until then, there were no stock splits and TDY for a long time had been the most expensive stock on the market.
Back to more recent examples.
We already mentioned Apple, so let’s look at Apple which is highly celebrated for being a buyback machine. Looking at dollars spent, this is even true.
But what did they achieve so far?
They really aggressively repurchased shares since Tim Cook took over, because Steve Jobs neither paid dividends nor did he any buybacks.
Over the last ten years and in order to repurchase a third of shares outstanding, Apple spent about 650 bn. USD (!) which especially in the beginning when the stock was lowly valued made a lot of sense by moving the needle decisively. However, especially over the last few years, the pace has come down – not due to less buybacks, but due to the high valuation.
Until the end of 2019, Apple traded for a market cap to free cash flow of below 20x, so that buybacks were meaningfully cannibalizing the company (20x means that with the full FCF 5% of stock could be repurchased theoretically; 30x is 3.3%, 25x is 4%, but 16.6x is 6%, 14.2x is 7%, 10x is 10%, etc.).
The lower the valuation, the higher the bang for the buck.
However, Apple did not spent all the FCF on buybacks and a certain portion was needed to offset dilution through stock based compensation. Just for reference.
Since then, however, the effect has come down much.
As said, 2–3% p.a. are peanuts for me.
Today, we can forget the big tech stocks regarding buybacks. At best, it’s great for bold, but meaningless headlines. The created economic value for the shareholder in many cases is almost negligible.
That’s the sad truth.
Let’s look at some other examples I stumbled upon while researching this weekly.
Take the maker of Tommy Hilfiger and Calvin Klein, PVH (ISIN: US6936561009, Ticker: PVH). I would even say that many know the brands, but not the company. Over the last ten years, they repurchased 26% of their stock (!). Unfortunately, the stock has not moved during this timeframe (dividends are negligible).
The reason?
I haven’t done a deep dive into the company, but what I can see from the raw data is that operating income has been almost trending sideways.
There’s no drive or growth dynamic.
However, the per share metrics due to the strong buybacks did increase pretty much by roughly doubling from 4–5 USD per share to more than 10 USD.
Effectively, this means that the stock is trading now for half the valuation – a PE of 10x which does not include any expectations for growth anyhow.
Is it worth it?
Management announced an increase of the active buyback program of the size of additional 2 bn USD. Compared to a market cap of just 6.2 bn. USD this look very attractive – almost another 30%. But the program runs until 2028, i.e. over the next four years.
Still, at current prices, they would absorb about 7–8% of their stock per year. In case the business does not go under (I do not see any moat), this could support the stock nicely. But I do not see any necessity to rush in as buybacks only and a cyclical business without the support from the supply side (think of oil or met coal) are not enough to convince me.
When sales go down, so will cash flows and buybacks. The risks are too high and the case does not look too compelling.
Another, though way more successful example is the case of Dollarama (ISIN: CA25675T1075, Ticker. DOL), the Canadian Dollar Store company I featured in a weekly more than a yer ago (see here).
Over the last ten years, the fast growing company bought back close to 30% of its stock.
At the same time, Dollarama’s stock is up by a factor of 6x.
They are still aggressively buying back their stock, however, with a valuation multiple in the high-20s, the effect has become minimal.
I really like the company and the stock, but it is too expensive.
source: TIKR
I have also found a negative example.
Foot Locker (ISIN: US3448491049, Ticker: FL) which is by no means a growth company, quite to the contrary.
Over the last ten years, their share count is down by even more than is the case at Dollarama, namely by more than a third – this theoretically should have resulted in an increased economic value of 50% for shareholders.
A third is already a good chunk (even though there are better examples). But lowering the share count is not all that matters.
The reality is a tough and different one, though.
They have been struggling because their suppliers, mainly NIKE (ISIN: US6541061031, Ticker: NKE) turned more towards selling their stuff online through their own website, but also exclusively through own stores.
Consumers on the other side have more options than just Foot Locker stores.
One could debate whether this is a slowly dying business. But it certainly has headwinds.
You can see above that the stock is down by almost 50% – despite having bought back a third of its shares.
As if this weren’t enough, they also turned their balance sheet from net cash to net debt, eradicating any further firepower.
No, thank you!
A few last thoughts and two examples that really smashed the button.
The first one is tobacco. In all honesty, they should at least massively cut the dividends, if not suspend them altogether. I know that they won’t do that until they’re forced to do so.
The only exception is Imperial Brands (ISIN: GB0004544929, Ticker: IMB), which I even for a brief moment thought about writing a research report about for my members. I brainstormed the thesis of a challenger winning through cheaper offerings and taking market share from premium brands that are losing disproportionately.
This is event taking place. But for how long?
Imperial’s business prospects are just not good enough and the case too risky. The other piece was their relatively aggressive buybacks. In 2020, they cut their dividend, started reducing the debt load (the balance sheet is the best among the big four). Since last year, they are aggressively buying back shares – on top of a 8–9% dividend yield.
That’s cheap, but likely for a reason.
Regarding the other three: Instead of paying out 6–10% in dividend yields, they could repurchase the same or even more in own stocks every year. Or buy back some bonds to lower the debt load. Both would positively impact those stocks – dividends don’t.
Their stocks would likely crater with such an announcement, freighting the dividend hunters who are the main shareholder base. But then going after a stock that potentially could trade for multiples of 5x or so – a no-brainer! The underlying business does not change. It is slowly dying and dividends are the last thing they need.
5x multiples – wait a second!
I have good news. Met coal companies are trading for such silly multiples.
Compared to tobacco that have big net debt in the books, many met coal companies have clean finances because external financing has become almost impossible for them due to the ESG framework.
Is it any wonder a company like Alpha Metallurgical Resources (ISIN:US0207641061, Ticker: AMR) repurchased in just two years more than 20% of their equity? Sure, there was the huge windfall during 2022 with high coal prices, but nonetheless, such companies trade at absurdly low multiples still.
Even after coal prices have come down again, AMR can repurchase easily 10% p.a.
They even suspended their dividend entirely to focus on buybacks. Maybe management ready the chapter about Henry Singleton?
Met coal is needed and will continue to be needed for steel production.
Even if the west does not care: Big steel producing countries like Japan, Brazil, India or China will continue to use met coal, because they want cheap ingredients and products.
That’s why my members more than a year ago received a research report about a competitor of AMR which is still an active case. First, the company was reducing its debt – now they have net cash. In parallel, they started with 50% of free cash flow for dividends and the rest for a mix of debt payments and buybacks.
Recently, they shifted meaningfully towards buybacks, because they trade for about a 5x multiple.
With the entire FCF, they could gobble up somewhere between 15–20% of their stock – per year. Unfortunately, they are still paying a small dividend which I hope gets suspended at some point. But 10% p.a. are absolutely realistic.
This is a case where the potential for a buyback monster clearly exists.
The last example I wanted to write about is Marathon Petroleum (ISIN: US56585A1025, Ticker: MPC) which is one of the biggest independent refiners. It also has a midstream, i.e. pipeline business.
After they sold their gas station business in 2020 for 21 bn. USD, they started with gigantic buybacks. Their market cap was less than 40 bn. USD. Until today, they lowered their share count by 37%, basically in a couple of years. They still seem to have gas in the tank, because besides the 21 bn. USD in cash received, they also had a strong year 2022.
But all in all, I think this case has lost somewhat the potential for a surprise and it seems to be in the last innings, as it is well known now (unfortunately, I only stumbled upon it late in 2023).
Since the buyback began, the market cap has doubled. The stock is up by more than 3x. At the same time, the business has been cooling down. The stock looks cheap, but it is not dirt-cheap.
Conclusion
Buybacks seem not to be properly understood – big total numbers are celebrated, but most often indeed only good for bold headlines.
One should know about how to best conduct buybacks and about the disproportionate effect with a lower share count – the more the way better.
If done properly, i.e. at low valuations, they can be brutally powerful and rewarding for patient shareholders.
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