Today it was reported IBM will borrow $2B.  Since IBM is sitting on a pile of cash and has record free cash flow one may wonder why they would borrow $2B.  Here is the WSJ article reporting this deal.

The $2B is split between a 2 year offering of $750M at 3 month Libor plus 7 basis points or about 0.47% and $1.25B at May 2013 TB plus 70 basis points or about 1.94%.  With IBM PTPM of about 14% and borrowing money at 0.47% and 1.94% you can see this looks to be very profitable for IBM.  This of course results in earnings growth in excess of revenues. The IBM Treasurer has been quite astute in the past to borrow money just before interest rates increased and this may perhaps be another instance of this.

If you look at the IBM Balance Sheet you will see about $25B in debt.  This may seem like a lot until you recognize IBM has a finance arm that lends money to customers who buy IBM products and services.  If you back out the amount of debt carried by the debt the base company has a rather low amount of debt. 

With the low US interest rates there has been a shift from the Yen Carry Trade to the Dollar Carry Trade resulting in much borrowing of dollars at very low rates and investing at higher return securities.  When you can borrow at 2% it is not too hard to make a great return. 

Dan 

I have yet to see a stock buyback that benefited me, unless the company was buying my shares back at a tremendous profit (to me). Buying someone else's stock at a tremendous profit to him doesn't do a whole lot for me.

Al, I agree dividends are preferable to me as well.  However given a choice of having the company keep the money as part of their net worth or pay it out via stock buybacks, I prefer the latter.

We can thank our Congress for causing the stock buy back phenomena.  Way back they decided execs were being paid to much (sound familiar) so in their ultimate wisdom passed a law they thought would prevent excessive pay by not allowing a salary of over $500K ( I think later raised to $1M) not to be able to be written off as an expense.  This is what caused the companies to issue stock options to key employees instead of higher salaries.  Since these key employees own options it is to their benefit to see the stock price rise which they can do via stock buy backs (less shares for the same earnings equals higher EPS) and of course that is what has happened.  Paying out dividends does not directly cause the stock price to rise. 

Of course you have to watch out to see if the stock buybacks are merely enough to cover the newly issued shares to pay the key employees their stock options.

So like most legislature passed by Congress the law of unintended consequences comes into play since there are always some in private industry who are just a little smarter than our Congress people who write (but do not read) our new laws.    

Dan

That may very well be, but stock buybacks do not unequivocally push up the price of the stock, even though Earnings Per Share may be increased; that's a whole lot different than saying, '...earning per share increase.' The former infers that EPS are being artificially moved/manipulated to reflect an artificial change (increase, in this case); the latter suggests that the fundamentals behind the figures are increasing.

What needs to be observed is the increase or decrease in Net Profits. That will tell one much about whether stock buybacks are unduly influencing growth in Earnings Per Share

AL,

You are correct but generally speaking share buybacks are a good thing.  As a shareholder what do you want your firm to do with the money they just earned.  They can give it to you in the form of a dividend, reinvest it back into company and/or buyback shares.

Dividends have many pro's and con's.  Once started they are hard to stop.  They have tax consequences.  Buffett pays no dividends because he can do better with the money than the shareholder.

Reinvestment back can be many things; pay off debt, hold for opportunity, increase R&D, etc etc etc.

Sharebuyback may be the best alternative for the shareholder.  The market may have so undervalued the firm.  It has little tax consequence on the share holder.

Some combination of the above.  EPS and Net Profit are means to evaluating those decisions.

Bob

I am open to concrete benefits of share buybacks. Personally, I don't know any

Al,

Who's in the best position to know the true value of a share of stock?  I'd submit it is the company itself.  When the market undervalues a stock, then that is the time to buy shares.  The company then uses shareholder money to buy stocks.  Each shareholder then profits by the purchase.  It is like insider trading. (G)  OTOH, if you don't believe the company has the shareholder's best interest at heart, probably time to sell the stock.

Bob

Al and Bob

I am open to concrete benefits of share buybacks. Personally, I don't know any

Al, here is one for your consideration.  In 2006 IBM established a 5 year plan to increase EPS from $6.05 in 2006 to $10 to $10.50 in 2010. This is a very challenging growth rate for a large company.  Thus far through 3Q09 they are ahead of schedule.  Part of this plan was an extensive buyback program that would add $1.10 to EPS by 2010 solely due to buybacks.  This of course is the net shares purchased minus the shares required for stock options.  Thus far they are ahead of schedule and analysts are now expecting EPS of $10.90 in 2010.  If this occurs then about 22% of the EPS growth was the result of share buybacks.  

From the beginning of 2006 the stock price of IBM has increased from 82.06 to 121.09 or about 47%.  I would suggest the share buybacks were a significant factor in this stock price rise.  During this same period the S&P 500 decline 18%.  I am not saying all of this delta was due to buybacks but I do believe it was a significant contributor.

The number of IBM shares outstanding has declined from 1506M in 2006 to a VL estimated 1200M in 2010.  Thus a decline in the number of shares outstanding of about 20% during this period.  This is an indication that although IBM has a lucrative employee stock option program the buybacks significantly exceeded the options given. This is something I see as important to observe when you are considering the benefits of a stock buy back.

Who's in the best position to know the true value of a share of stock?  I'd submit it is the company itself.  When the market undervalues a stock, then that is the time to buy shares.  The company then uses shareholder money to buy stocks.  Each shareholder then profits by the purchase.  It is like insider trading. (G)  OTOH, if you don't believe the company has the shareholder's best interest at heart, probably time to sell the stock.

I do not believe the bulk of the stock buybacks are company executives buying back shares because they see them as undervalued.  Most are part of longer term programs to periodically buyback shares.  The key here is knowing when a stock is undervalued.  If corporate mgmt was astute enough to know this for certain they could likely make more money simply trading stocks.  However I do agree company officials know more about their company and are in a better position to know the value and thus would tend to buy more when the price is undervalued.  I think corporate treasurers give higher priority to the required strength of the balance sheet to run the business as opposed to buying undervalued shares.  How many bought on March 6 of this year clearly as ideal time to buy?

Dan

Dan,

EPS is only one test and can be manipulated or at least I think that was Al's point.  Long term eps manipulation is very very difficult.

I didn't mean that a company was in the position to trade stocks but rather had insight to  when to buy and sell.  In fact, I've seen cases where although the board authorized buybacks, they were not executed but of financial reasons.  I would think at least one would be value.

Bob

Al

After reviewing the 2008 Annual Report for IBM, the following figures standout:

2006 Net Profits: $ 9.492B
2008 Net Profits: $12.334B
Three-year Compound annual growth in Net Profits: 9.1%

2006 EPS: $6.11
2008 EPS: $8.93
Three-year Compound annual growth in EPS: 13.5%

Although EPS grew at a 50% greater rate than Net Profits, I fail to see where share buybacks did nothing for me as a shareholder, nor for any other shareholder. The company grew (by profit standards) 9.1%. The market place has rewarded IBM shareholders a value based upon how the market views IBM's ability to continue to grow their profits, not their EPS; this is what increased my value, not stock buybacks. If there were no share buybacks (nor issuance of additional shares), IBM's earnings would have grown at the same rate as Net Profits, and the market place most likely would have rewarded IBM's ability to grow [their Net Profits] with the same enthusiasm.

Yes the future estimated growth rate of EPS will determine the PE Ratio investors will apply to a company.

I believe the market places too much importance on EPS growth AND share buybacks, and too little importance on Net Profits - until too late in the game. Share buybacks have very little, if anything, to do with growing the company, nor enhancing my value.

I have a differing view. (bg)  While earnings may be important if you own the entire company, I believe that for an investor it is the EPS that is important.  When I own shares in a company my interest is the EPS.  This is in line with the SSG methodology where PE Ratios are an important consideration. 

Think about a company that doubles its earnings but in doing so doubles the number of sahres available.  A shareholder basically sees no increase in value despite the company doubling earnings.

One of my favorite questions to ask of Investor Relations folks when they brag about stock buybacks and EPS growth is for them to also relate all of this to Revenue and Net Profit growth. The follow-up usually indicates that share buybacks led to a more impressive EPS number

Revenue growth and profit margins of course are imnportant.  But it is the bottom line that is important for a shareholder. 

Another measure I use in evaluating a stock is the free cash flow yield.  This of course is (FCF /Shares)/Stock Price.  Using Morningstar data and a current price of $122.74 this comes out to 10.7%  [(17605/1338)/122.74].  When I see a company producing Free Cash at a 10.7% in this economy I view that as quite good.  Of course you can do the same thing with EPS and calculate the earnings yield.

Dan