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Thoughts On Buying Back Shares
Posted on | June 10, 2011 | 1 Comment
Several of the stocks in our dividend portfolio are involved in massive share buyback plans. In fact, Walmart just recently announced a new $15 billion share buyback plan. This brings up some important questions on investing, namely whether we prefer management to allocate cash into share buybacks or into dividend payments to shareholders. Let’s look at a few important points.
Reinvesting into the company
For a company like Walmart, the shares haven’t moved much in a decade. It is likely that management views the shares undervalued. At this point in my investing career and with my view on Walmart, I would be reinvesting any dividends back into Walmart shares. In fact, I have a DRIP active for Walmart so it happens automatically.
Since that is the case, it actually works out great that management is buying back shares. Rather than incurring a tax on the dividend and then buying back shares, the company is essentially doing it directly. While sometimes management for various companies has been known to buyback shares in an attempt to mask the dilution caused by stock options granted to themselves, you can see the material impact of buybacks at the following pages:
As you can see in the above pages, the decrease in outstanding shares is very real. With many of the stocks we own, buying back shares at current levels seems like a great idea when coupled with a sound dividend policy.
Borrow money to buyback shares?
It can get more interesting when companies are borrowing money and buying back shares at the same time. Some of our companies have chosen not to go this route. Raven Industries (RAVN) for example has no debt, and pays dividends more frequently than buying back shares.
Other companies like Walmart have indeed been borrowing increasing amounts of money while increasing the share buyback plans. Allow me to explain why I don’t have a problem with it. The interest rates on the debt is at historic lows. Walmart is paying next to nothing on the capital accumulated by issuing bonds.
Meanwhile the free cash flow yield on the shares of the stock is still significant. As such you might deduce that borrowing money to buy back these shares is a great investment. Since Walmart, McDonald’s, Microsoft and other companies can tap the global debt markets and get capital at insanely low rates, I actually prefer management to be taking advantage of this. Sure it is nice to see a company with no debt, but if the return is there, I’m ok with accessing the debt market as these companies have done.
I like buying back shares as long as these companies have steady cash flows. I also like it when the company views its stock as undervalued as many of these do. These stocks don’t get nearly the attention as the “sexy” high fliers that most people in the public focus on (such as Apple). As such, these stocks often get unnoticed. We’re fine with this as it allows attractive buying opportunities and buyback opportunities for management.