C&B Notes

Share Buybacks Done Right

We have previously written about the foolishness of buying back stock at elevated valuations as this capital allocation choice destroys shareholder value.  While this corporate trend remains in vogue regardless of valuation, Teledyne’s Henry Singleton was the vanguard of an opportunistic, contrarian approach for taking advantage of a mispriced stock — as currency for acquisitions when it was overvalued and as an investment when it was undervalued.

Excerpts of interview with Will Thorndike, author of the iconoclastic The Outsiders:

The way to think about Henry Singleton is that he demonstrated kind of unique range as a capital allocator.  He built Teledyne [in the 1960s] largely by using his very high P/E  to acquire a wide range of businesses.  He bought 130 companies, all but two of them in stock deals.  Throughout that decade his stock traded at an average P/E north of 20, and he was buying businesses at a typical P/E of 12.  So it was a highly accretive activity for his shareholders.

That was Phase One.  Then he abruptly stops acquiring when the P/E on his stock falls at the very end of the decade, 1969, and focuses on optimizing operations.  He pokes his head up in the early ‘70s and all of a sudden his stock is trading in the mid single digits on a P/E basis, and he begins a series of significant stock repurchases.  Starting in ‘72, going to ’84, across eight significant tender offers, he buys in 90% of his shares.  So he’s sort of the unparalleled repurchase champion.

When he started doing that in ‘72, and across that entire period, buybacks were very unconventional.  They were viewed by Wall Street as a sign of weakness.  Singleton sort of resolutely ignored the conventional wisdom and the related noise from the media and the sell side.  He was an aggressive issuer when his stock was highly priced, and an aggressive purchaser when it was priced at a discount to the market.

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Corporate America’s track record buying in stock is just horrendous.  It’s terrible.  We are now again approaching a peak of buyback activity, no matter how you measure it.  The prior peak occurred in the second half of 2007, the last market peak.  The trough in corporate buyback activity?  Early ’09. So, kind of a perfect contra-indicator for the stock market.

Not surprisingly, many studies have shown that buybacks don’t produce great returns.  But there are very different approaches to buybacks, and they produce very different outcomes.  The typical way that corporate America implements a buyback is the board announces an authorization, which is usually equal to a relatively small percentage of market cap — low to mid single digits — and they then proceed to implement that authorization by buying in a specific amount of stock every quarter.  Sort of a metronome-like pattern.  And generally the amount of stock they repurchase is designed to offset options grants.

The approach of the CEOs in the book was entirely different.  It was pioneered by Singleton, and it involved very sporadic, sizable repurchases.  I mentioned that Singleton bought in those 90% of shares over eight tender offers.  The largest was the last one, which he did in 1984.  He bought in 40% of shares outstanding.  He tendered for 20-25% and there was excess demand, so he bought in all the shares [that were offered to him].

It’s very different mindset.  You’re looking at a stock repurchase as an investment decision with a return and you’re comparing that return to other alternatives, and when it’s attractive you’re aggressive in implementing it.