October 5, 2014 Comments

On Friday the S&P 500 gained 1.2% while Toronto was up 0.2%. Almost all of the stocks on my list were up.

Wal-Mart will be updated shortly and most likely rated (lower) Buy. Not an exciting investment but probably a fairly safe one.

Walmart has bought back 25% of its shares over the past years and at relatively attractive prices. We like that.

Walmart has continued to grow despite share buy backs and dividends paid and without taking on excessive debt. It can do this because it has been a highly profitable and cash generating entity.

Speaking of share buy-backs…

One of the strange but well accepted fictions is that share buybacks return money to share holders just like dividends do. It may well be the same thing from the companies perspective but it is definitely not the same from the perspective of share owners.

Share buy backs return money only to departing share owners. If the share price was where it should be the continuing owners own a larger share of a company with a bit less money than it had before the buy back. It’s a wash from the perspective of continuing shareholders unless the shares were bought back at a good price. Often that is the case. Sometimes it is not.

To illustrate:

Imagine if 5 people owned 20% each of a local Boston Pizza Restaurant owned through a corporation. One wants to sell out and the ownership corporation has the money to buy back the shares of the departing owner. It’s clear to see that the remaining four now own 25% each of a restaurant that no longer has the money that was just paid to the departing owner. Money has been returned to the departing owner and not to the four continuing owners. In contrast a dividend returns money to all owners. If the restaurant continues to do well the four remaining owners may well benefit by their increased ownership. But that is not a given. And the restaurant may need to borrow money now that its cash has been depleted by the buy-back. It is not necessarily the case that the earnings per share of the four remaining owners will increase. However that is likely the case if the cash used to buy back the shares of the departee had been sitting earning little return. But the point is that a corporation buying back shares certainly does not return money to the non-selling share holders by buying back shares. For whatever reason the fiction that this is the case seems widespread.

Theorists may point out that the share buy back is exactly like a dividend if all owners sell back the exact same proportion of shares. But no one would suggest that this ever happens in reality. Also the tax consequences would differ.

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