In this presentation, we discuss share repurchases and everything you need to know about them. We also present some insightful quotes from the world's best investors on the proper implementation of share repurchases in real-world scenarios.

1. Share Buybacks: What You
Need To Know
With Nick McCullum from Sure Dividend

2. What are Share Buybacks?
Share buybacks (also called share repurchases or stock repurchases)
are the most misunderstood way for a corporation to return cash to
shareholders.
This misunderstanding is unfortunate…because share buybacks are very
powerful. They reduce the number of shares outstanding and make each
investor’s share of the business more valuable over time.

3. Basic Example of Share Buybacks
Imagine a business with the following characteristics:
1. $1,000,000 of annual earnings
2. 10 partners
3. Each partner owns 10% of the business
4. The business pays out 50% of its profits every year to its owners
5. This means each owner receives $50,000 per year

4. Basic Example of Share Buybacks
Now, imagine that one of the partners wants to ‘cash out’.
Everyone agree the business is worth ten times earnings, or $10 million.
The business spends $1,000,000 of company money to buy out the partner.
After the partner sells out, the business is still making $1,000,000 per year
and paying out half that money to its remaining 9 owners.
The only difference is that each owner now owns 11.1% of the business.
Instead of receiving $50,000 per year, the remaining 9 owners will receive
$55,556 even though the business did not grow.

5. Share Buybacks and the Stock Market
The ultimate goal of rational shareholders is to maximize the per share value
of the businesses they own.
Share buybacks increase per share value by reducing the number of shares
outstanding.
Said another way, share repurchases increase your percentage ownership
in the business even if the business does not grow.
To show how powerful this can be, the next slide shows a hypothetical
business that you own 1% of with a constant price-to-earnings ratio of 15
that uses 75% of its earnings on share buybacks each year.

8. Share Buybacks and the Stock Market
The shareholders’ fractional ownership increased from 1.00% to 4.66% over
a period of 30 years. Assuming a constant valuation multiple, this represents
annualized returns of of about 5.3% per year without any business growth.
When the business is growing, repurchasing shares generates some very
interesting results.
On the next slide, we’ll examine the the amazing compounding power of a
business that:
1. Grows earnings at 5% per year
2. Trades at a price-to-earnings ratio of 15 (as before)
3. Uses 75% of earnings on share repurchases (as before)

11. Share Buybacks and the Stock Market
After 30 years, you would have 21.79x your initial investment. This amounts
to annualized returns of 10.8% per year.
…not bad for a business growing at “just” 5% per year.
The “trick” is that the business was very shareholder friendly and allocated
capital very well. It is also important that the hypothetical business stayed
reasonable cheap (a price-to-earnings ratio of 15) the entire time.

12. Share Repurchases, Dividends, & Taxes
If taxes didn’t exist (don’t hold your breath), the effects of share repurchases
would be identical to the effects of reinvesting dividends.
In a tax-free environment, dividends are preferable to share buybacks
because they give you the option of:
1. Reinvesting back into the company (i.e. a share repurchase)
2. Buying stock in a different business
3. Using the cash dividend on consumption

13. Share Repurchases, Dividends, & Taxes
Unfortunately, we do not live in a tax free world. Think of all the taxes a
dividend must experience before it reaches you:
1. You are taxed on the income you earned to invest in the stock market
2. The corporation is taxed on income it made to pay the dividend
3. Your dividend payment itself is taxed
Are share repurchases better for shareholders? It depends on the situation.
Dividend payments are taxed. Share repurchases are not. This makes share
repurchases a more tax efficient strategy for returning capital to
shareholders than dividends.

14. Share Repurchases, Dividends, & Taxes
Unfortunately, we do not live in a tax free world. Think of all the taxes a
dividend must experience before it reaches you:
1. You are taxed on the income you earned to invest in the stock market
2. The corporation is taxed on income it made to pay the dividend
3. Your dividend payment itself is taxed
Are share repurchases better for shareholders? It depends on the situation.
Dividend payments are taxed. Share repurchases are not. This makes share
repurchases a more tax-efficient strategy for returning capital to
shareholders than dividends.

15. Share Repurchases & Stock Prices
So far, we have only spoken of the benefits of share repurchases. Share
buybacks can sometimes have the unintended consequence of destroying
shareholder value.
How is this possible?
Share buybacks destroy shareholder value when performed when a
company’s stock is trading above its intrinsic value.
To understand why, we’ll use a fantastic analogy provided by Berkshire
Hathaway’s Warren Buffett:

16. Warren Buffett on Share Repurchases
“In the investment world, discussions about share repurchases often
become heated. But I’d suggest that participants in this debate take a deep
breath: Assessing the desirability of repurchases isn’t that complicated.
From the standpoint of exiting shareholders, repurchases are always a plus.
Though the day-to-day impact of these purchases is usually minuscule, it’s
always better for a seller to have an additional buyer in the market.”

17. Warren Buffett on Share Repurchases
“For continuing shareholders, however, repurchases only make sense if the
shares are bought at a price below intrinsic value. When that rule is
followed, the remaining shares experience an immediate gain in intrinsic
value. Consider a simple analogy: If there are three equal partners in a
business worth $3,000 and one is bought out by the partnership for $900,
each of the remaining partners realizes an immediate gain of $50. If the
exiting partner is paid $1,100, however, the continuing partners each suffer
a loss of $50. The same math applies with corporations and their
shareholders. Ergo, the question of whether a repurchase action is value-
enhancing or value-destroying for continuing shareholders is entirely
purchase-price dependent.”

18. Warren Buffett on Share Repurchases
It is puzzling, therefore, that corporate repurchase announcements almost
never refer to a price above which repurchases will be eschewed. That
certainly wouldn’t be the case if a management was buying an outside
business. There, price would always factor into a buy-or-pass decision.
When CEOs or boards are buying a small part of their own company,
though, they all too often seem oblivious to price. Would they behave
similarly if they were managing a private company with just a few owners
and were evaluating the wisdom of buying out one of them? Of course not.
It is important to remember that there are two occasions in which
repurchases should not take place, even if the company’s shares are
underpriced. One is when a business both needs all its available money to
protect or expand its own operations and is also uncomfortable adding
further debt. Here, the internal need for funds should take priority.
This exception assumes, of course, that the business has a decent
future awaiting it after the needed expenditures are made.

19. Warren Buffett on Share Repurchases
“The second exception, less common, materializes when a business
acquisition (or some other investment opportunity) offers far greater value
than do the undervalued shares of the potential repurchaser. Long ago,
Berkshire itself often had to choose between these alternatives. At our
present size, the issue is far less likely to arise.”
My suggestion: Before even discussing repurchases, a CEO and his or her
Board should stand, join hands and in unison declare, “What is smart at one
price is stupid at another.”

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