One Industry Focus: Financials listener recently asked why smaller investors should care about stock buybacks. After all, it's not going to make a substantial difference in their ownership percentage of the company. In this clip, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss three big reasons why all investors can benefit from stock buybacks.
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This video was recorded on April 8, 2019.
Jason Moser: Next up, we wanted to talk about a listener question we got recently. This comes from Adam Wilson. Adam tweeted this to us, @AdamFWilson426. He says, "Hi! Love the shows and I'm a member." Thanks, Adam! Glad you love these shows, and thank you for being a member and trusting us with your financial independence there. "I have a question about buybacks. I understand that it increases my ownership at a company. But being a retail investor, I own a very small percentage anyway. For example, I own about 80 shares of Starbucks. There are 1.243 billion shares outstanding. It doesn't make much difference to me that they buy back shares. It won't make a substantial difference in my ownership over the time I hold the company. Why are buybacks good for people like me?"
Matt, I think we have a few thoughts regarding this matter. I'm going to let you kick it off here. What do you think about what Adam's saying?
Matt Frankel: You're correct in the sense that a buyback is never going to increase your percentage of ownership to a substantial level. For example, my Apple stock, Apple's buying back shares very aggressively right now. My ownership is never going to get to where I am a significant stakeholder in Apple. That's not the point. The point is that, over time, this will inherently make your shares more valuable. For example, let's say a company's buying back 4% of its stock each year, which a lot of companies are doing, in that ballpark. Over a two-decade period, they're going to buy back roughly half of their stock. By that logic, your shares will inherently be worth about double what they are right now. That's not including any profit growth and things like that.
Buybacks can also be a really tax-efficient way to get capital returned to you as a shareholder. Let's say a company was buying back your stock instead of giving you a dividend. You don't have to pay tax on that buyback until you sell. Whereas if you get a dividend from that company, you pay tax right away. The other way is if a company could buy back stock for less than it's actually worth, which is the Buffett rule. Berkshire Hathaway just modified their buyback plan so that Buffett and Charlie Munger can buy back stock whenever they think it's trading at a discount, which is clearly in investors' best interest. This is like if a company were buying $100 bills for $90. Of course you'd want them to buy as much as possible. From that standpoint, it definitely creates shareholder value. This is why I love the big bank buybacks that have been going on. Wells Fargo has been buying back like 10% of its stock this year. It's great, because if they're correct, and its intrinsic value is worth a lot more than its trading for, then shareholders are making a lot of money in addition to the company's profitability.
So, although you're never going to be a major stakeholder in Starbucks if you're starting with 80 shares, that doesn't mean you shouldn't care about buybacks. They're still a really great way for a company to return capital.
Moser: Yeah. To your point there, it essentially is looking at it from the perspective that really, all shares are created equal. Whether you have one share or a million shares, every share is an equal unit. To your point, that buyback over time, in theory, should shrink that share count, thereby making your shares, in theory, more valuable. That's one of the questions I always have with buybacks. The data out there is pretty clear that more often than not, management teams get share buybacks wrong. Oftentimes, they buy those shares back when the stock is trading at these lofty multiples, and everything is going hunky dory. Then all of a sudden, the you-know-what hits the fan, and then they start pulling at the purse strings there, and nobody's buying back anything when that's actually when they should be buying back more stock. So, you do have to pay attention to that, understand that if they are buying those shares back, take a look at the balance sheet over time. See, is that share count coming down over time? If it's not, that's a big problem.
On the one hand, dividends, yeah, that's cash in the pocket, but to your point, you're going to pay a tax on that. Whereas buying back shares, making those shares a little bit more valuable over time, you won't pay the tax on that until you sell. So, you see the pluses and minuses for both.
Ultimately, the point to look at it is that every share really is the same unit. All shares are equal there in that regard. Whether you have 80 shares or 1,000,080 shares, you're going to recognize some value through those share repurchases, assuming that management is actually doing a good job in the repurchases to begin with. Again, that's not always a given. You have to approach these buybacks with at least a healthy dose of skepticism. Take a look and make sure that when they're making those buybacks, the share count is coming down over time. That's really one of the key points to look at. You can find that information on the balance sheet over time. I like looking at stretches of five years. You can really get an idea, how much are they spending on buybacks? How much has that share count come down? Does it make a little sense? That can give you the answer to how well the company's being managed.
Very good question there, Adam. Appreciate you firing it up here for us. Hopefully we were able to give you some things to think about.
Jason Moser owns shares of AAPL and SBUX. Matthew Frankel, CFP owns shares of AAPL and BRK-B. The Motley Fool owns shares of AAPL, BRK-B, and SBUX and has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool has a disclosure policy.