“Returning Money to Shareholders” – a Good or Bad Idea?

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.

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About rosshealy

C. Ross Healy, MBA, CFA Chairman, Strategic Analysis Corporation Ross Healy began his investment industry career in 1965 as a securities analyst for Midland Osler Securities. He was a co-founder of Sceptre Investment Council in 1970, a leading Canadian money manager. In 1984, he became Director of Research at Merrill Lynch Canada, and during this time provided support for the late Dr. Verne Atrill, the theorist who decoded the mathematics underlying the Theory of Accounting Dynamics upon which the Strategic Analysis Corporation (SAC) methodology is based. After supporting and collaborating with Dr. Atrill for many years, he joined SAC as Chairman and CEO in 1989 following the death of Dr. Atrill. Ross Healy is a past president of the Toronto CFA Society, and served on the board of the Financial Analysts Federation (now the CFA Institute) as Chairman of the Financial Analysts Journal committee, the academic arm of the CFA Society. He has served on the Financial Disclosure Advisory Board of the Ontario Securities Commission, and was a member of the Executive Committee of Trinity College, University of Toronto, chairing the Investment Committee. He currently serves as the Chairman of the Board of Trustees of Eglinton St. George’s United Church of Toronto. He contributes investment analysis to print, radio, and television media, and has been appearing regularly on Business News Network (BNN) for the past 15 years, and the Canadian Broadcasting Corporation (CBC). There is an award-winning book written about his analysis leading up to the collapse of Nortel Networks (The Bubble and The Bear, How Nortel Burst the Canadian Dream, by Douglas Hunter, Doubleday Canada, 2002. He was the “Bear” in the book.). Email Address: rhealy@strategicanalysis.ca Company Website: www.strategicanalysis.ca Telephone (work): 416-498-3604 x 133 Cell: 416-258-8342
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3 Responses to “Returning Money to Shareholders” – a Good or Bad Idea?

  1. Great call – HD should be using their shares as currency at that P/B ratio to purchase assets that are under-priced.

    • rosshealy says:

      Of course, HD should. But these days, it seems that you are a poor corporate citizen if you are not “returning money” to your shareholders. Many companies will live to regret that they bought back stock when they should have issued it.

  2. rosshealy says:

    What I suspect will happen is that some time 20-30 years out, we will look back on this period of stock buybacks and wonder what had been going through the heads of those corporations. All the evidence points to the reality that companies that buy back expensive stock (on a price/book basis) under-perform the stock market in the future.

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