Although many investors like to see companies spend their cash on dividends, internal investments and acquisitions, share buybacks are an equally valid use of cash. In fact, when share prices are falling, such repurchases may actually be the best use of cash.
To my mind, buybacks in tandem with dividends (what we here at StreetAuthority call “Total Yield”), underpins one of the most profitable opportunities in investing.
Get A Total Yield From Your Investments
Some investors are no fan of buybacks. They note that repurchases made when a stock is trading near 52-week highs appear ill-timed.
Even when share prices are high, share buybacks can benefit the company.
Companies are not like individual investors which measure their returns on the price of stocks compared to the price when they purchased.
While companies are under no obligation to complete their authorized buyback programs when the market hits a rough patch, repurchase programs are typically instituted with a multi-quarter time horizon, and companies rarely cease such programs out of fear when the market is falling.
Moreover, a fixed pace of repurchases could mean a steady demand for the company’s shares, even as other stocks sell off during market jitters.
This Company Is Rewarding Shareholders With Higher Dividends and Buybacks
When I look for companies that are capable of robust total yields, I focus on the outlook for cash flow and sales. I want to know that a company can complete its repurchase authorization program and put more money in my pocket.
Delta Airlines (NYSE: DAL) completed a $2 billion share repurchase program in June 2015, and has already announced a new $5 billion buyback program. In addition, the company increased its quarterly dividend by 50%, to $0.135 per share from $0.09 per share.
On an annualized basis, the buyback adds a 5.7% yield to the 1% dividend yield. The shareholder cash return of approximately $2.4 billion a year is just 65% of the company’s free cash flow booked over the last four quarters and leaves plenty of room for growth.
Delta is benefiting from low fuel costs, new passenger fees and a healthy economy. Sales have jumped at a compound annual rate of 7.5% over the last five years and cost measures are improving profitability.
The bulk of the company’s hedging contracts on fuel prices expired in the first half of 2015, which means that fuel costs will be significantly lower for the rest of the year. With $3.8 billion in balance sheet cash already, I expect the company to complete the new buyback program early and to continue returning cash to shareholders.
This Fast-Food Heavyweight Plans To Return $1.4 Billion In Share Repurchases
Wendy’s (Nasdaq: WEN) announced its largest buyback program ever in June, authorizing up to $1.4 billion in repurchases through the end of 2016. That amounts to nearly 52% of the company’s current market capitalization.
Add the company’s 2.3% dividend yield to a potential annual share buyback yield of 34%, and the company could potentially offer an annualized total yield of 37% through 2016.
And Wendy’s has the balance sheet strength to do it. The company has over $1.2 billion in cash and annual cash flow exceeds $200 million. Cash flow is likely to improve in the years ahead, as the company optimizes its operations and benefits from the divestiture of a bakery division.
As part of its optimization program, Wendy’s is targeting a franchise mix of 95% (from its current 85%) which will help to cut costs and improve profitability. The shares are priced at just 1.34 times sales, less than half the valuation on McDonald’s at 3.52 times sales, and well below the 6.9 times sales multiple for shares of Restaurant Brands International (NYSE: QSR), which owns Burger King and Tim Hortons.
Risks to Consider: Companies are not obligated to complete buyback programs and may cut share repurchases to conserve cash in an emergency. Make sure fundamental growth and cash flow outlook supports upside in your investments.
Action to Take: Build a position in these shareholder-friendly companies as their total yield rises in tandem with the market pullback.
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Source: Street Authority