Company Buybacks: Value Creation or Value Destruction? Lessons From Henry Singleton

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Company Buybacks: Value Creation or Value Destruction? Lessons From Henry Singleton

Over the past decade, companies especially US companies have been constantly conducting share repurchases. As we all know, in theory share repurchases is definitely a good thing as it shows that company’s management feels that current prices do not justify the true value of the company. Furthermore, share repurchases increases shareholder’s value as well given the decrease in outstanding shares. However, this might differ in practice. As investors we should always question ourselves if share repurchase is truly the ideal move by management.

History:

Henry Singleton, C.E.O. of Teledyne is also known as the father of modern stock buyback. During the 1960s, he built up Teledyne largely through using his very high P/E shares of 20x to acquire a wide range of businesses trading at lower multiples of ~12x. Throughout the entire period of company acquisitions, nearly 130 were funded via stock deals. During the second phase of late 1969s when the P/E of his stock fell he began focusing on optimising company’s operations. Following this in the early 70s, when his company’s P/E was trading at single digits, he begun a series of share buybacks.

According to Buffett, if one took the top 100 business school graduates and made a composite of their triumphs, their record would not be as good as that of Singleton, who incidentally was trained as a scientist, not an MBA. The failure of business schools to study men like Singleton is a crime, he says. Instead, they insist on holding up as models executives cut from a McKinsey & Company cookie cutter

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John Train, The Money Masters

Food for thought:

As mentioned previously, US companies in general have been jumping onto this new ‘trend’ of share buybacks. However, are they truly following the same steps as the late Henry Singleton?

Is management truly allocating money efficiently? It has been proven that in many cases, company management are good business managers, however, bad capital allocators. Buying shares during times of boom and cutting back buybacks when stocks prices decline. During the pre-financial crisis in 2009, many companies were big buyers of their own stock, only to reduce or halt their buyback programs during the market crash. Furthermore, as seen in recent times where the S&P500 has been constantly hitting new highs, managements have begun buying back shares once more.

The questions that should arise from this would be, assuming management buy back the shares at what P/E are they doing this at? I use the P/E ratio in this example for simplicity. Assuming a company’s share is trading at P/E 20x, that would mean a return of 5%. Could management have done better investing that money in T-bills? Moreover, given a stock being a more risky asset, one should expect to receive a much higher return compared to the T-bills. Furthermore, the company could have paid out the excess cash as a dividend, allowing shareholders to invest the money elsewhere, possibly in less richly valued shares. Does management has other motives for buying back shares rather than paying dividends? Buybacks can push share prices up, making management’s stock options more valuable. Instead of buying back stock like everyone, management could perhaps use that capital to better optimise their operations or invest in new business initiatives. However, with this one has to aware of management’s investment track record. There are many out there who diversifies for the sake of diversifying. At times, focusing on their core business which is their main competency would be a much better route.

Summary:

During this decade, investors should always question issues such as share repurchases. Is management truly good capital allocators? While management buying back stock may indicate that the current price is undervalued and worth buying, however, we have to think deeper as management may not truly know what they are doing.

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I developed my passion for investment management especially equity research at a relatively young age. My investment journey began when I was 20, at a point in time where markets were still recovering from the Global Financial Crisis. My portfolio started from money I saved over the past years and through working during the holidays. I was fortunate to have a good friend with common investing mentality to began my journey towards value investing. To date, we still research and invest in companies together, discussing valuations and potential risks of a company. To date, I manage a fund with a value investing style. Positions are decided upon via a bottom-up approach or smart speculation (a term I came up with when buying a stock for quick profit due to a mismatch in prices in the market due to takeovers/selling of a subsidiary or associate). Apart from managing my own portfolio, I enjoy sharing my research with family and friends, seeking their opinions and views towards the stock. Reading Economics in London, I constantly keep up with the financial news in Singapore & Hong Kong. Despite my busy schedule, it has not stopped me from enjoying other aspects of life. I enjoy a variety of activities in whatever free time I may have – endurance running, marathons, traveling, fine dining, whiskey appreciation, fashion. Lastly, I enjoy meeting new people, discussing ideas and gaining new perspectives towards issues in the world.

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