I know that share repurchases are really unpopular as a way to return capital to shareholders. There is some weird belief that share repurchases are poorly timed and, at best, just a way to pay for stock-based compensation when shares are given out to executives.
I’ve heard it a billion times.
The argument ignores actionable information, however, in that a reduction in share count of any firm worth owning is obviously a good thing.
Everyone knows what a P/E ratio is – it’s the price of the company divided by the annual earnings of the company. A company which sells for a PE of 10 would sell for a price 10 times its annual earnings. So, in 10 years, if you were to purchase the company outright, your purchase price would have been returned to you in earnings.
IBM currently sells for a PE of 14, which is reasonable for a tech services giant. Suppose that you were to purchase 1 share of the firm today for just under $200. You would own less than 1 billionth of this colossal, beastly company. You wouldn’t even exist as far as owners go. You’re just one person, with one share.
Now suppose that for the next 14 years the valuation of the company (PE of 14) remains the same, and that the earnings are consistent and in the form of positive cash flows. Suppose also that IBM puts 100% of its earnings into share repurchases.
In just under 2 decades, presuming you never sell your shares, you will be the sole owner of the last remaining share of IBM. Because the company reinvested all of its earnings into repurchases, and you never sold, you now own the whole entire company. And it only cost you $200 to eventually own this $200 billion behemoth.
Share Repurchases Rock!
This example is filled with exaggeration and some assumptions that do not prove true in the real world. First, earnings are never 100% cash, nor do companies see the same valuation for 14 years straight. Stock prices go up and down.
The point is, however, that most retail investors tend to look at shares only as if they are ticker symbols. Most IBM shareholders would probably be happy if, for the next X number of years, IBM shares were to rise by an average of 10% per year. Good enough, right? $200 today, $220 next year, and $242 by 2014 would keep most people happy enough not to care why or how the stock gains value.
But shares are more than just ticker symbols. Letters do not have intrinsic value – the ticker symbol IBM is worth nothing. The company that it represents is what gives it value.
Over time, the powerful compounding that happens when companies repurchase shares and increase the proportional ownership of each individual share is incredibly valuable for current owners. Unfortunately, most never see it, because few people actually care to see how much that share is actually worth as a percentage of ownership.
So, please, can we start asking for repurchases? I’d like to own the whole of the companies in my portfolio – you can have your dividends when we’re all 10% owners thanks to rapid buybacks. Until then, I’m game for more cannibalism.