Tuesday, March 26, 2019

Income investor view of five stocks buying back shares

I am always interested to learn how stocks  use their cash. When I saw this article on stock buy backs, I decided to look at the stocks mentioned through the eye of an income investor.

  •  Stock buy backs reduce the number of shares for ordinary investors which could lead to stock price inflation
  • Income investors prefer dividend increases to stock buy backs
  • Stock buy backs can cause stock ownership to be concentrated among a small group of investors 
  • Solid dividend machine fundamentals remain the best metrics for successful income investing.

Stock buy backs strong in fourth quarter 2018.  The full Reuters report can be viewed here:  http://pdf.reuters.com/htmlnews/htmlnews.asp?i=43059c3bf0e37541&u=urn:newsml:reuters.com:20190325:nPn8NsQkTa


The five issues with the highest total buybacks for Q4 2018 are:

  • Apple (AAPL) led in buybacks, spending $10.1 billion in Q4 2018, down from $19.4 billion spent for Q3 2018. Its Q4 2018 expenditure ranked 19th highest historically; for the year, Apple spent $74.2 billion on buybacks, up from 2017's $34.4 billion; over the five-year period the company spent $229.0 billion, and $260.4 billion over the 10-year period.
  • Oracle (ORCL): $10.0 billion for Q4 2018, down from $10.3 billion for Q3 2018; 2018 was $29.3 billion, up $4.0 billion in 2017.  
  • Wells Fargo (WFC): $7.3 billion for Q4 2018, slightly down from the $7.4 billion spent in Q3 2018; 2018 was $21.0 billion, up from $10.3 billion in 2017.
  • Microsoft (MSFT): $6.4 billion for Q4 2018, up from $3.7 billion for Q3 2018; 2018 was $16.3 billion, up from $8.4 billion in 2017.
  • Merck (MRK): $5.9 billion for Q4 2018, up from $1.0 billion for Q3 2018; 2018 was $9.1 billion, up from $4.0 billion in 2017.
Buy backs are an interesting aspect of the market.  Buy backs are touted as benefiting the stock owner.  With fewer shares in the open market, your shares should be worth more money.

As an income investor, I would prefer the company pay or increase my dividend.  Some companies use a lot of debt to buy back shares such as Home Depot, symbol HD. Is it worth it to leverage the balance sheet to run up the value of the stock?

Stock Buybacks and Stock Market Inflation

For ordinary investors, stock buy backs are more problematic on a macro scale.  When you have too much money chasing too few goods which in this case we are talking about stocks, the price of the goods goes up.

The income investor class is growing as baby boomers retire and look to live off the income their money makes instead of living off the income their jobs provide.  Lots of money chasing only a few investments that pay income makes for price inflation.

We have price inflation on dividend stocks and price inflation on fixed income such as municipal and corporate bonds.   We are faced with price inflation on every income option. 

In a healthy economy we want ordinary investors to be able to own stock in the companies that affect their lives.  We don't want ownership concentrated in just a few hands even if that is the teachers pension plan.

An income investors view of these five stocks

Let's look at these five stocks and see if despite fewer shares being available they are still good investment options.

We income investors start with how these five stocks compare on dividend machine fundamentals.  You can find my Dividend Machine criteria here:  http://www.themoneymadam.com/p/dividend-stock-criteria.html

As you can see, Oracle is a bit high on debt and low on yield but once they decided to share some money with their investors, the dividend growth is very good.  All stocks except Merck have a very safe payout ratio which means the dividend and the dividend growth rate is safe.

Of the five stocks noted above, only Oracle, has piled on debt recently.  Yet their debt to equity ratio is not even close to HD.    See the graph below.  The other stocks have very reasonable debt levels so balance sheet quality is not an issue with them.  They could pay us a dividend just as easily as buying back stock.  All stocks provided very good dividend growth over the past three years with Oracle being the best dividend growth stock of this group.

In this case, perhaps Oracle's debt increase funded dividend growth rather than stock price appreciation.  We will look at other metrics later in this post.

Oracle's increasing debt load.

Let's now look at how their stock prices have performed during the time they were paying out dividends and buying back stock.

Microsoft, MSFT, is the winner on price appreciation with Wells Fargo the laggard.  Eighty percent is a pretty good average for picking growth stocks no matter what the reason for the price increase.

Let's look at the earnings growth over the same period of time.  Perhaps earnings are the catalyst for growth in stock price.

Notice that EPS and price increases are the common element for the leader of this group which is Microsoft.

My conclusion is that while stock buy backs may not be the best for the ordinary investor on a macro scale, I don't think stock buy backs are any reason to buy a stock or to avoid a stock.

Good fundamentals including solid balance sheet, increasing earnings per share, a dividend and dividend growth are still the income investor's best metrics for successful investing.

M* MoneyMadam

Disclosure:  Long MSFT, AAPL,