In a recent post (https://ftalphaville.ft.com/2019/11/13/1573644284000/A-quick-look-at-US-buybacks/) FT Alphaville discussed buybacks.

With 2020 in sight and the U.S. Presidential Campaign, we will read more and more similar headlines. If you add debates around how real wages have increased (or not) over the last 10 years or the different social widening gaps, you can be certain that you will be reading a lot about share buybacks in the next 12 months.

I would like to start with a 10 years picture of S&P 500 Buybacks:

Looking at the chart above, it is fair to say that there has been an acceleration of share buybacks in the U.S. over the last couple of years.

With earnings yield above the after-tax cost of debt, companies have a huge incentive of using buyback. Looking at earnings growth for the S&P 500 in 2020, which stands at the moment around 11-12%, we should assume that 1/2 of it comes from buybacks.

For example, below is the Top 20 U.S. share buybacks in $m (source: S&P IQ):

 

Apple	$18,154
Bank of America	$6,507
Oracle	$6,301
JPMorgan	$5,210
Cisco Systems	$4,936
Wells Fargo	$4,906
Microsoft	$4,633
Johnson Controls International	$4,125
Alphabet	$3,577
Citigroup	$3,464
Intel	$3,049
Booking Holdings	$2,718
Johnson & Johnson	$2,486
Amgen	$2,415
Biogen	$2,402
Visa	$2,152
Lowe’s Companies	$1,944
Mastercard	$1,921
Honeywell International	$1,900
Facebook	$1,752

Apple, thanks to his Cash Flow generation and Cash pile, is sitting at the top. No surprise here.

But could all those companies afford a share buyback and did we experienced a recent acceleration in share buybacks?

On the second question, we should be looking at the two ways of rewarding shareholders (I am not talking about stock price going up here): dividends and buybacks. To get a fair picture, we have to combine those two and analyze recent trends.

Below 10 years of Dividend Yield and Buyback Yield for the S&P 500:

	Dividend Yield	Buyback Yield	Dividend and Buyback Yield
2009	2.0%	1.4%	3.4%
2010	1.8%	2.6%	4.4%
2011	2.1%	3.6%	5.7%
2012	2.2%	3.1%	5.3%
2013	1.9%	2.9%	4.8%
2014	1.9%	3.0%	5.0%
2015	2.1%	3.2%	5.3%
2016	2.1%	2.8%	4.8%
2017	1.8%	2.3%	4.1%
2018	2.2%	3.8%	6.0%

I see two things here: at 6%, 2018 was the highest year in terms of shareholders reward. 2018 was not very far from levels seen in 2011 though, ie two years after the Great Financial Crisis.

After looking at this big picture, I would like to cover more fundamental analysis.

When we are analyzing a company, we should know both its dividend yield and whether it has an active share buyback. As always when we look at quantitative analysis, we should be looking at past trends, recent trends and expectations. For example, when covering a company that is helpful to analyze the last 5-10 years and what the market’s expectations for the next 2-3 years.

Share buyback programs have specifics and we should be analyzing them before entering a position: the total amount, the time frame (when is it expiring), the minimum purchase price, the maximum purchase price, the maximum daily volume allowed…

But as underlined before, when looking at dividends and buybacks, we want to know if a company has the means to reward its shareholders with such dividend yield and share buyback program. If they can afford doing so.

That is where we should be looking (but not only) at Free Cash Flow = FCF.

FCF represents the cash generated after cash outflows to support operations and maintains its capital assets. When studying a company’s FCF, we should be able to identify how the company could finance its growth, pay its dividends, buyback shares or reduce its debts.

Let’s start with a game by trying to identify dividends/buybacks/FCFs for the five companies below: Apple, Walmart, Amazon, McDonald’s and Microsoft. Try to guess which data belongs to each company:

Company A	2014	2015	2016	2017	2018
Dividends	(3.22B)	(3.23B)	(3.06B)	(3.09B)	(3.26B)
Share Buyback	(2.96B)	(5.78B)	(10.87B)	(4.23B)	(4.8B)
Free Cash Flow	4.15B	4.73B	4.24B	3.7B	4.23B
FCF – (Div. + Buyback)	-2.03	-4.28	-9.69	-3.62	-3.83

Company B	2014	2015	2016	2017	2018
Dividends	(11.13B)	(11.56B)	(12.15B)	(12.77B)	(13.71B)
Share Buyback	(45B)	(35.25B)	(29.72B)	(32.9B)	(72.74B)
Free Cash Flow	50.14B	70.02B	53.09B	51.15B	64.12B
FCF – (Div. + Buyback)	-5.99	23.21	11.22	5.48	-22.35

Company C	2014	2015	2016	2017	2018
Dividends
Share Buyback
Free Cash Flow	1.95B	7.33B	9.71B	6.41B	17.3B
FCF – (Div. + Buyback)	1.95	7.33	9.71	6.41	17.3

Company D	2014	2015	2016	2017	2018
Dividends	(6.19B)	(6.29B)	(6.22B)	(6.12B)	(6.1B)
Share Buyback	(1.02B)	(4.11B)	(8.3B)	(8.3B)	(7.41B)
Free Cash Flow	16.39B	15.91B	20.91B	18.29B	17.41B
FCF – (Div. + Buyback)	9.18	5.51	9.71	3.87	3.9

Company E	2014	2015	2016	2017	2018
Dividends	(13.81B)	(9.88B)	(11.01B)	(11.85B)	(12.7B)
Share Buyback	(18.4B)	(13.81B)	(15.3B)	(11.02B)	(9.72B)
Free Cash Flow	38.26B	23.72B	24.98B	31.38B	32.25B
FCF – (Div. + Buyback)	6.05	0.03	-1.33	8.51	9.83

To get the answers, you will have to watch this short video which comes from the Video 18 of the 4×4 Video Series – https://gregoiredupont.com/education :

 

[fvplayer id=”43″]

 

After watching this, you probably understand that behind the topic of share buyback lie more important issues:

How is the company generating FCF? What is the FCF trend? What FCF generation should I expect from that company based on its product cycle and the sector drivers? What are the market’s expectations? Can the company afford (or not) such a dividend and/or buyback? Are dividends and buybacks financed by FCF generation or with debt? Is the company under leveraged or using too much debt?…

In your investment process, you want to be able to generate ideas with different filtering, different criteria. Analyzing Free Cash Flows is a great booster to understand how a company is doing.

On the topic of FCF vs (share buyback and dividends), you could be looking at how the Free Cash Flows have been trending over the previous years and what are the growth expectations. Then you could compare on how over time a company is able to generate FCF and cover its dividends and buyback. If it is not covering then you might then have a problem.

And you could do this analysis on both a yearly trend and quarter trend, but that would be for another blog…

As mentioned above McDonald’s has been using leverage for many years now to finance buybacks and dividends. Similarly, General Electric was struggling over the last few years. As always and as the oil sector showed in 2015-2016, one of the questions to answer is to know if deterioration or improvement in FCF is just temporary or more structural.

Looking at earnings growth expectations, we should then consider which part is “organic” = coming from GDP growth and which part is from reducing number of shares for instance. We always need to keep in mind that buybacks in the long run should be financed by FCF. Meaning that in a downturn or slowdown, they will be affected.

To finish one a positive note, I would like to share the Top 20 Free Cash Flows expectations for the next 3 years.

Company	2020e	2021e	2022e
AAPL	61,238	63,164	67,264
MSFT	39,063	44,978	45,078
AMZN	29,457	38,285	51,140
T	28,094	27,652	26,407
GOOGL	27,473	34,992	41,884
JNJ	19,843	23,706	26,490
FB	19,069	22,694	28,324
VZ	17,907	19,460	19,644
WMT	16,067	16,763	17,230
CVX	15,204	16,826	16,052
CMCSA	14,595	16,620	17,856
INTC	14,447	15,285	16,319
UNH	14,265	17,095	20,091
CSCO	14,218	15,444	15,368
ABBV	13,443	18,267	19,726
ORCL	12,831	13,345	14,590
TFX	12,513	14,827	18,414
PG	12,372	13,059	14,047
V	12,056	14,711	16,920
IBM	11,949	12,441	12,830

That is almost $1.4 Trillion of FCF expected to be generated in the next three years by those 20 companies alone. Or the top 20 FCF combined for 2020e represent roughly the Gross Domestic Product of Norway.

I hope it helps,

Gregoire