Watching BNN today, I noted an analyst who recommended Home Depot because, among other positives, the company had been “returning cash to shareholders by way of share buybacks”. A quick look at the valuation of the company – currently 14 times book value – told me everything fallacious about that statement that I really needed to know. Can you see it yourself?
The company is not returning cash to its shareholders at all. It is buying 7 cents of its own cash in the bank and paying $1.00 out of its own treasury for that 7 cents. That means that each and every shareholder is being diluted, not enhanced, but diluted, by 93 cents for every dollar that the company has spent repurchasing its own stock. The “winners” in this deal are the shareholders that have wisely sold their shares to Home Depot and thereby avoiding being diluted themselves. A look at the SVA chart of HD on our client website shows in fact that the book value per share is falling – not rising, but falling – creating negative value for shareholders.
Now, because there is a sort of fad these days that says that buying back stock (returning cash to shareholders) is a good thing, the share price of HD has managed to hold up for the time being, but there will come a day – there always does – when existing shareholders discover that they, too, should have been selling to HD as well, because what has been happening is that the book value – your pillow of fundamental value at night – is getting thinner and thinner.
And the same goes for any company that is selling for a multiple of book value in the market. These companies should be issuing stock and increasing the book value (and cash on hand for expansion) for their shareholders, not p—ing their money away to suit the fashion of the times.