by Will Ashworth | September 7, 2012 6:30 am
Best Buy (NYSE:BBY) has a bit of a shopping addiction. And it needs to stop.
According to The Wall Street Journal‘s CFO Report, Best Buy has repurchased more than 98 million of its shares since April 2010 at a total cost of $3 billion, or roughly $30 a share. At its Sept. 5 closing price of $17.91, it has lost $1.2 billion on its investment.
That means to get back to breakeven, its stock must rise in value by 67%.
Clearly, Best Buy has squandered shareholder funds at a time when it is fighting for its very survival. BBY demonstrates why share repurchases should be the choice of last resort. We should explore others that are equally stupid, but first, let’s look at just why Best Buy’s share buybacks were such a bad idea:
By now we all know that Best Buy’s second-quarter earnings stunk, making an adjusted profit of $68 million, or 20 cents per share — a calculation based on 340 million shares. Add back the 98 million shares it repurchased over the past two-and-a-half years, and the per-share profit drops to 16 cents.
You could make the case that a 20% drop in the quarterly EPS (beyond the already pitiful report) would exert significant downward pressure on its stock price. On the other hand, you also could argue that if it kept the $3 billion in cash and instead paid out a 75-cent special dividend in each of the last nine quarters, the stock price wouldn’t be nearly as woeful today. If a business can’t figure out what to do with its excess cash, it should give it back to shareholders. While buybacks pretend to do that, dividends actually get the job done — regular or special.
Now, onto the others.
My first example of stupidity is Apple (NASDAQ:AAPL), which I first wrote about in March when it announced it was giving back $45 billion in cash to shareholders over the next three years. I believe that the dividend yield produced by Apple’s gesture is meaningless to anyone who is a serious income investor because it’s too small to matter and exposes one to an unacceptable level of risk given the reward.
Further, assuming its stock price keeps rising (the iPhone 5 is coming out shortly), it’s going to be purchasing its shares at levels approaching $800, which means the buybacks won’t even cover the dilution from management stock options. Unless Apple commits serious money ($100 billion or more) to buybacks to reverse the effect of dilution due to executive compensation, it’s a complete waste.
Up next is Hewlett-Packard (NYSE:HPQ), which repurchased 262 million shares in fiscal 2011 (October year-end) at an average cost of $38.55 a share. That’s a total return of -55% as of the Sept. 5 closing price of $17.27. HPQ has done a little better in the first six months of fiscal 2012 buying back 43 million shares at $25.58 each; a loss of 32%. In the past five fiscal years, it has repurchased 1.06 billion shares at an average cost of $42.36, for a negative return of 59%. An investment of $45 billion is now worth $18.3 billion.
CEO Meg Whitman has been in the job almost a year now, and if the second quarter is any indication, HPQ has definitely taken its foot off the share repurchase pedal. Hindsight is 20/20, but $45 billion invested in its stock today would reduce its share count to zero, and the employees would own the entire company. I realize it’s an implausible scenario; I’m simply illustrating what a colossal waste buybacks often are.
One of the ways I evaluate the success or failure of a share repurchase program, in addition to the total return, is to look at the average price paid by a company in relation to the average price of its stock during the period under review. The bigger the discount translates into bigger success.
Factset‘s (NYSE:FDS) Buyback Quarterly lists the top 10 stocks based on share repurchase discounts for the trailing 12 months ended March 31, 2012. The stock with the biggest discount is Ecolab (NYSE:ECL) at 59.5%. It bought back its stock at an average price of $32.49 when its average stock price during the 12 months was $54.60. The payback for buying smart was a total return of 24.1%, far superior to the 6.2% return for the S&P 500.
Unfortunately, the practice isn’t perfect. The next-best stock in terms of a discount is Eastman Chemical (NYSE:EMN) at 63.3%. Its total return over 12 months was -1.9%.
According to Greg Milano, CEO of Fortuna Advisors, “From 2008 through mid 2011, nearly two out of three companies in the S&P 500 had negative buyback effectiveness.”
Credit Suisse analyst David Zion released a report June 18 that examines the effectiveness of share repurchases and found that between 2004-2011, S&P 500 companies spent $2.7 trillion buying back stock. Only 180 were able to achieve a return higher than a 7% cost of equity (the annual return most investors expect from a stock), and just 98 companies did better than simply using dollar cost averaging.
Of the 10 worst performers, it’s no surprise that six were financial companies. The worst performance by a non-bank is Sprint Nextel (NYSE:S), which managed to lose $3 billion over eight years. Its annualized return is -31%. If the CFO was a chief investment officer, he or she would be fired in a heartbeat. (If you get a chance, have a read of Zion’s report. It’s an eye-opener.)
Warren Buffett is on record stating that he will buy back Berkshire Hathaway (NYSE:BRK.B) stock whenever it is trading at or below 110% of book value. It’s too bad Best Buy management didn’t pay attention to the master, because they could have saved shareholders a whole lot of money and grief.
Stupid is as stupid does.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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