Some Words On Share Buybacks II

Regarding Intel’s recent announced debt increase some general words can be said regarding buybacks. Something on the subject was already posted on part I here.

Buying undervalued stock makes sense to me. Buffett says he will buy his company stocks if they get cheap (under 120% of book value). And he has bought big amounts of IBM, a company famous, among other things, for their huge buybacks. So apparently buybacks of undervalued conditions makes sense to Warrent Buffett. He does not blindly believe in market efficiency and he thinks it induces investors to avoid thinking and finding undervalued companies. In that sense I am grateful that so many believe in market efficiency, it keeps intelligent competition off the table. He said “I’d be a bum on the street with a tin cup if the market was always efficient”. On his famous speech against the theory of market efficiency he showed several examples of investors profiting from market inefficiencies: The Superinvestors of Graham-and-Doddsville.

It’s great if companies use cheap debt with artificially low interest rates to buy cheap stocks. It is similar to buying a cheap house using debt at historical lows. Its even a greater move if inflation and higher interest rates comes after the debt was incurred. In such case callable bonds, their debt, can be bought back at lower prices. On the other extreme, using expensive debt to buy overvalued stocks would be a terrible move. If shares are bought then there are fewer outstanding stocks and fewer shares to pay dividends to. Therefore they have to pay less cash on future dividends.

Another point to consider is that bond coupon payments from the new debt is deducted from operating income therefore less cash flows go to the government via taxes.

This case is specially good considering that Intel’s dividend yields are much higher than their newly incurred debt yields.

It could be even better, depending on how low the stock price is, if they could use cheap debt or preferably their own cash, to invest profitably in their company. But if they already have enough cash to do that and the stock is cheap enough, this move is good.

With respect to the question:

“I am still failing to understand how shareholders get any cash from share buybacks. Can you please explain that to me?”

As I see it if a company buys back all its shares then 100% is given back to public shareholders. In such case the company goes private and is financed by private owners or creditors. If they buy x% fraction of shares then x% is given back to the ones who sold it back to the company. The shareholders willing to sell at lower prices give back their shares. There remain fewer owners or less shares.

If bonds are sold to buy the shares then the company’s debt is increased but the shares are reduced. If you believe debt is cheap and stocks are undervalued this is a great move. Creditors are bigger now, but there are fewer owners or less outstanding shares. This improves the income and cash per share ratios since profits are divided on fewer owners or shares. Credit or debt is increased while owners are reduced.

Cheers and Merry Xmas!
jrv

PD1: I originally commented this on the Intel article Smart Investors Should Ignore The Gimmick Of Intel Share Buybacks. The current version of the comment is edited with more information. Some other interesting articles on the subject are Intel Debt Plan Is A Great Financing Move and Intel’s Big Buyback Will Roast The Bears

PD2: Here is an excellent comment on the same subject for those that want to keep learning: http://seekingalpha.com/article/1072341-smart-investors-should-ignore-the-gimmick-of-intel-share-buybacks#comment-12948911

About jrv

I was born in Spain and lived in Belgium, Chile, France, USA, Argentina among other places. Currently I am trying to settle down in a wild place. I am "retired", even though now I dedicate more hours "working" for my investments than I ever worked in the real labor market where I used to work in IT and Banking. I am a family man, I have a lovely wife, several sons and one step daughter. I have humble tastes, I like to stay home and read about companies and investments. I started investing at 25 before the internet bubble exploded. I did not know much about investing and liked technical analysis so my results were pretty bad. Fortunately I did not have much to lose. Some years later in 2006 bored of doing only real state investments and with quite a lot of money saved I opened an account in a cheap and excellent online broker and started again. This time I did not want to commit the same mistake, so I decided to follow a model. I heard that Warren Buffett was the best at making money via stocks so I started by reading a lot about him, all of his shareholders letters and several of the books that he recommended. I learned a lot, started applying his investing principles and reading a lot of 10K's. Digested news from lots of different sources. Basically I started buying very good and cheap companies and holding them for ever if possible and if nothing changed fundamentally. When the housing crisis started I was more than 75% cash. At that time I identified good companies at incredibly cheap prices so I invested most of my savings in stocks. In less than I year I doubled. By the second semester of 2009 I turned my software company into an investment vehicle and dedicated myself full time to it. My wife and I decided to change our lifestyle and moved from Belgium to the beach in a wild country. The goal was to keep fixed costs low in order to be able to live with a minimum 6-8% yearly return but specially to move away from the inhuman life of civilization and to have finally some peace and sunny weather to concentrate better on investing. Now I can think and study about companies 60 hours a week and I am doing great. I can finally do what I want full time and can proudly say that I have never been so happy, specially also with my just born 4th son, my other great kids and my sweet wife who supports me fully while I study most of the day and patiently wait for the opportunity to make a swing ! You can learn a bit more about my portfolio by viewing it at www.kuchita.com/view/sumo.php or you may learn more about me and my family by following the link "Author's site" from the menu above.
This entry was posted in General and tagged , , . Bookmark the permalink.

The Intelligent Investor Blog Posts Feeds

Receive posts by email?