Carl Icahn recently spoke at the Reuters Global Investment Outlook Summit. The activist investor suggested that share buybacks hide the poor performance of badly run companies. He stated: “Very simplistically put, a lot of the earnings are a mirage … They are not coming because the companies are well run but because of low interest rates.”
Interestingly, despite his stance on buybacks, he’s pushing Apple (AAPL) to repurchase $150 billion of its stock. Nonetheless, his point about share repurchases is accurate — they are a poor proxy for operational excellence. Eric Reguly goes further in an excellent Globe and Mail article from October, suggesting share repurchases destroy innovation.
Share repurchases aren’t all they’re cracked up to be. Here are a few examples illustrating why.
From 2001 to 2012, Intel (INTC) spent $67.7 billion repurchasing its shares, just $2.5 billion less than it did on research and development. Now, it’s true that some tech firms can go overboard on R&D, but INTC is hardly the poster child for overspending on research.
Share repurchases are a different matter altogether. In 2002, INTC posted diluted earnings per share of 19 cents. In 2012, that number jumped to $2.13 per share — a compound annual growth rate of 22.3%. That’s an excellent growth rate over such a long period. However, if you use net income rather than EPS, the figure drops to 19.6% — 270 basis points less per annum.
That might not seem like much, but if you invested the $67.7 billion spent on share repurchases at 2.7% (the difference) for 12 years you’d have an additional $25.5 billion or $3.70 per share at 2001’s share count of 6.9 billion. Furthermore, if you paid this out as a special dividend today, it amounts to a 14.9% yield. What’s not to like about those numbers?
In the twelve years between 2001 and 2012, the average company in the S&P 500 bought back $600 million of its stock annually for a grand total of $3.5 trillion, according to Professor William Lazonick, an economist at the University of Massachusetts Lowell. Buybacks peaked in 2007, the year before the market crash.
IBM (IBM), for example, repurchased $18.8 billion of its stock in 2007 — more than it repurchased in the two previous years combined. Paying an average of $105.39 per share for those shares, its annualized return on investment in the six years since is 10%, 430 basis points better than the SPDR S&P 500 (SPY).
But the problem is that most companies are terrible at timing buybacks, and unskilled at properly valuing themselves.