The Hidden Cost of Share Repurchases: Are Investors Getting a Raw Deal?

During their latest episode of the VALUE: After Hours Podcast, Carlisle, Taylor, and Bloomstran discussed The Hidden Cost of Share Repurchases: Are Investors Getting a Raw Deal?. Here’s an excerpt from the episode:

Christopher: When you had Brewster on a couple of weeks ago, you guys were talking about a little bit of this, book values are very understated relative to replacement costs. That has a lot to do with amount of share repurchases that take place at premiums to book. Company like Starbucks doesn’t have any equity, because they bought back so much of the stock we own it. So, we have no book value in that one. But you couldn’t rebuild Starbucks today without a lot of capital and a lot of money. And then you’ve got some historical assets as well.

But still, so if you’ve got book value for the S&P at a little over 1,000 on a per share basis, that gets you to $9 trillion, let’s call it, market cap of a little over $40 trillion. Sales are more like 1,850 or 1,900, so almost twice book. But point being, a 20 ROE is not right, but it is what it is. But there’s so much leverage sitting next to the equity that does exist. They’re almost like amounts that the return on capital for the S&P is 12 and ours is 15, where if you own the S&P 500 for the last 20 years, you get about a third of your profits distributed to you as dividends. And all of the balance, more than all of the balance because it got augmented with debt, has gone to share repurchases. You’ve only shrunk the share count by seven-tenths of 1% each year for the last 20 years. But they’re giving away almost 3% to themselves on the front end. So, it’s not anti-dilutive.

If you go back 25 years, 25 years, we’ve done this experiment of share repurchases consuming two-thirds of profits. The share count for the S&P 500 is unchanged. [Jake laughs] Two-thirds of all the money earned by all shareholders in aggregate went to repurchasing shares, and there’s no change in the share count.

Jake: Where’d all the money go? [laughs]

Christopher: Where’d all the money go? Now part of it gets recapitalized when the banks blow up in every financial crisis.

Jake: Right.

Christopher: And so, you get a ballooning share count oddly in the last two quarters, the share count is up despite repurchases at still very high levels, although below the cadence of a year ago. And so, we largely own businesses that we get way less in dividends. Berkshire skews this, because they don’t pay a dividend. But we only get about 17% of our aggregate profits coming to us as dividends. So, the balance, which is the preponderance. We own businesses, and part of our mission is to find companies that actually have places to reinvest money at the returns on equity and capital. Some of our companies, like an Olin, don’t. But largely they do.

And so, the Semper portfolio is not being reinvested just in share repurchases to offset dilution, giving money to executives. We own companies where you have more of a founder mentality, where these folks really are trying to find places to reinvest in their businesses or bolt on acquisitions that make sense and are done at economically logical level. I think that’s what drives our return over time. That’s what’s driven our return over the last 25 years. It’s the preponderance of our profits actually being reinvested in companies that do invest in those returns, and not at 20 times earnings with two-thirds of your profits, which is a 5% earnings yield. That’s how your S&P for the last 25 years, which was expensive during the tech bubble, but the S&P has done 7% a year. That’s it. You make 5x your money. You make [unintelligible 00:27:39] 10.5%, you make twice that. And you’re sitting here today at those similar valuations and corporate behavior that’s doing exactly what it’s done for the last 25 years. And that’s burning up a whole bunch of corporate profit.

Jake: And maybe it has to almost be this way because of the pro cyclicality of share buybacks and pushing prices up. But I’m going to guess like on a dollar weighted basis, what do you think that over the last 25 years, the purchase price on a PE basis has been of these buybacks?

Christopher: Well, it’s your multiple of the market. You haven’t been far off of 20x to earnings. We’ve been very few times in the last–

Jake: And nobody was buying back when it was cheap. That’s my point. 2008, people were initiating equity and not doing buy backs.

Christopher: No, the share count went way up 2008 and 2009. Again, that was the financials in the bank. So, when things get really cheap, even early in the pandemic, everybody suspends their share repurchases because you worry about needing the capital in case things get really bad when you’re in a financial crisis like 2008, 2009. Beyond the banks, repurchases slow, which tells me there’s something perhaps going on in the economy today. And it’s not just all of a sudden, a rationality by your CFOs and your CEOs. Something has slowed the share repurchase cadence in the last half year. And I think it’s business conditions that were probably weaker for a lot of businesses and a lot of industries. And it’s all the inflation as well.

If you’re having to give money to labor, which has suffered for the last two or three decades, if you can’t pass through price and you’re eating it on margin, well, that’s less operating income that can go to share repurchases. If you’re a dollar general that we own, they’ve got some blocking and tackling issues, which made the stock really cheap, which we took it up from 2% of capital a year ago to 10. Bought our last block when we took it from 4% to 10% at 113 a share. It’s 160 today. But they cut their share repurchase. The stock was trading at a [chuckles] massive discount, but they put some debt on the books to buy shares back when the thing traded at 22 times earnings, and you’d rather have them buying it today.

So, Apple, when it was cheap– Part of the beauty of why Apple was so good is they started paying a little dividend quarter of their profits. But then they really ramped up their share repurchases. And only in the last three or four years did the stock go from a low 10s multiple to earnings. Well, they haven’t slowed the share purchase. But because you’re trading it 30 times, you’re retiring a far smaller proportion of the company. So, there’s no price. It doesn’t seem like there’s a price sensitivity with a company like Apple. I’d put most companies in that camp where there’s no price sensitivity. They’re simply trying to offset dilution by making themselves all fatter and happier.

Tobias: That’s one thing that Jake and I have talked about offline, possibly, that Buffett praises Apple for a lot of those buybacks that seem to me that they happen at prices that, are as you say, they’re just price insensitive, where he’s anything but– He’d just rather that they spend it on Apple stock than go and buy something silly?

Jake: Get an Apple car.

Tobias: Like, Go and buy GM or something. Yeah.

Jake: [chuckles]

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