I like Oil

[Jmlstocks]

I have to ask: Why would you hate a company that buys its shares back-that's a good thing if you're a shareholder

[Running_Man]

Because what Chevron does is very often the case of share buy backs, by definition they are buying back stock when they are doing good and the stock price is high. Especially for companies that can be cyclical in nature it means when times are bad and they could use cash to buy assets of other companies at cheap prices they no longer have the cash to do so and frequently end up issuing shares or debt to maintain the company.

In Chevron's case in 2013 and 2014 they bought back over 9 billion in stock at 20-25% higher prices meaning over 2 billion dollars in cash used for stock purchases was totally wasted in an effort to prop up a stock price in a manner that cannot be maintained. Now they are cutting capital spending by 5 billion because of a shortage of cash.

Share buybacks are done almost exclusively for short term stock gains for the benefit mostly of near term issued stock incentive awards for executives and have little in the way of long term planning for corporations.

Some companies such as Berkshire Hathaway only repurchase their stock when price is in a value range and they have significant cash to take advantage of special circumstances, in those cases it is strategic, but in most it is not.

[Jmlstocks]

I see your point on companies that are cyclical in nature, could be a sign that they're buying at a high point.

I know from history that stocks doing heavy buybacks have outperformed over the long term, that's why I wondered why you said that. I don't think a buyback is an automatic reason to like a stock, I've always viewed it as a nice added bonus.

[Totoro]

There is basically two common ways to get unproductive excess cash out of a company and transfer wealth to shareholders. One is dividends, the others is stock buybacks.

Dividends have a tax disadvantage.

Stock buybacks on the other hand have an effect of removing short term shareholders that value your stock the least and concentrating shareholding, which might be argued is a positive.

The big issue with buybacks is the valuation as running_man said. Buying back stock when it's below its real value is a good thing for the remaining shareholders, you are buying at a discount.

Buying back stock when it's above its real value however is only good for the selling shareholders - the long term holders and remaining shareholders get a bad deal.

In other words, buying back stock is a great thing to do provided that 1) there is no productive way to reinvest the excess cash in the business and 2) your stock is below its true (intrinsic) value.

In practice though companies tend to buy back stock only when 1) is fulfilled and forget about the 2) part. Sometimes they even forget about the 1) part.

As running_man said sometimes this is willful as a CEO wants to meet its short term incentive plan and/or has stock options about to vest. Can hardly blame the CEO for that though, blame the board for setting the wrong incentives ...

[FUEGO]

Wait, what? Share buy backs reduce the number of outstanding shares thereby increasing the earnings per share by making the denominator smaller. What's not to like about an EPS increase? Maybe they flubbed the timing and could have bought it back cheaper later, but overall it tends to be a positive sign.

[haha]

Quote:

Originally Posted by FUEGO Wait, what? Share buy backs reduce the number of outstanding shares thereby increasing the earnings per share by making the denominator smaller. What's not to like about an EPS increase? Maybe they flubbed the timing and could have bought it back cheaper later, but overall it tends to be a positive sign.

If you pay more than the stock's basic value, you are destroying value. If you pay less, like a few companies that are very well managed and good capital allocators, you are accruing value.

Ha

[aja8888]

Quote:

Originally Posted by FUEGO Wait, what? Share buy backs reduce the number of outstanding shares thereby increasing the earnings per share by making the denominator smaller. What's not to like about an EPS increase? Maybe they flubbed the timing and could have bought it back cheaper later, but overall it tends to be a positive sign.

The immediate EPS increase is generally recognized as the result of the buyback and not an increase in earnings based on performance. Laying out the huge sum of cash that could be used for future CAPEX or acquisition of a strategic asset places the company in a potential disadvantaged position.

[Jmlstocks]

I personally like the fact that the excess capital is taken out of the hands of management. Too much capital often results in inefficiency

[aja8888]

Quote:

Originally Posted by Jmlstocks I personally like the fact that the excess capital is taken out of the hands of management. Too much capital often results in inefficiency

Like management bonuses...?

[Running_Man]

Let me give two companies that are in the S&P500 that have been I think excellent examples of people who think the share reduction is wonderful yet in the same time I think it is just a lazy management way of increasing share price while slowly destroying the company:

1st McDonald's in 2005 McDonalds dropped managements prior commitment to expanding into casual healthy dining that they had been involved in with Boston Market and Chipotle. They owned 90 percent of Chipotle and has been instrumental in expanding the chain from 16 original stores to over 500 led by McDonald's leadership. Rather than hold on to that investment and grow with it McDonald's sold it's stake leading to the Chipotle IPO for one billion dollars in 2006. Today that stake would be worth over 20 billion dollars, worse than that they built a chain that is single handedly destroying McDonald's for lunches.

Now McDonald's did retire from 2006 to 2015 33% of their shares and for a couple of years from 2006 to 2013 as their share reduction and focus on dividends seemed to make the company more profitable per share the price rose. However by the end of 2013 it became apparent that McDonald's has fallen out of step with the economy and had no strategy other than to convert cash to dividends and share repurchases with the stock is falling, with sales only up 20 percent in actual terms in the nine years from 2006 to 2015.

Because management was focused on converting cash flow to share repurchase it held the stock up very well, but they didn't focus on how to improve their business. Even as the PE of McDonald's has expanded under this share repurchase program and ZERP from 14 to 20 the underlying business is getting weaker and weaker. Long term debt has gone from 7 billion to 14 billion, dividends have gone from 34 percent of income in 2005 to 66 percent in 2014. As a result of these actions book value remains at only 14 dollars per share.

Now let's look at another company IBM that in that same time frame 2006 to 2014 has reduced their share count by forty percent. Their revenues over this time have been flat but because of share repurchases it looks like 40% growth in per share sales. They are spending 1/ 2 the amount of capital spending that they averaged in the years 1998 to 2001. As the initial push of this share repurchase pushed up shares they doubled the stock price from 2006 to 2010, yet despite getting even more aggressive with the share repurchase program, increasing long term debt with easy financing from 22 billion to 36 billion dollars the stock has done nothing the last three years. So now the same sales that supported 22 billion in long term debt is now supporting 36 billion in long term debt, while the company is struggling what IBM would have to do on it's present course is increase the long term debt to 50 billion over the next few years to support the stock, this of course is merely wasting corporate resources but there are many investors who believe this is a great thing with such low interest rates. If rates were to pop up I do not know what companies like this would do other than have falling stock prices, this is the biggest bubble that the federal reserve has created corporate debt for share repurchases, I dislike it personally.

Overall my main point is a massive share repurchase program usually signals a management team that is timid and afraid and wants to play it safe and not one you would normally want to invest in because they lack a corporate vision, the current interest rates have exacerbated this problem as many companies can borrow for cheaper than their dividend rate meaning they can increase the dividend in their shares merely be retiring stock, but this is not a business plan this is short term thinking at it's finest. When interest rates rise the folly of companies that engaged in the most egregious examples of this will be exposed.

I cannot help but believe that Chevron wishes they had the 9 billion they used to buy stock back last year at an average price of 120 to instead buy assets that are available in a fire sale right now instead they are cutting capital and their normal budget even more.

[clifp]

You make good points Running Man. However certainly for a business like McDonald and to a less extent IBM, there aren't any obvious high growth areas to invest in.

Domestically I am sure that McDonalds store saturation was reached long ago,and international it has to be slowing. I'd expect McDonalds to have same store revenue at approximately inflation say 2%, and new store growth match population plus emerging markets another 2-3%. I'd expect them to maintain gross margins. I really have no problem with them borrowing money for as cheaply as Mcdonalds has <1% 5 years 2% 10, and long at 3.5% when their dividend is also at 3.5%. The companies 55% increase in dividends over the last 5 years is nothing to complain about it.

If I owned MCD (I don't) I'd expect 3-4% dividend yield and 4-5% dividend growth going forward. I agree a certain amount of innovation is vital for any company, and over the last 5 years McDonalds has pretty much failed that. But on the other hand I wouldn't buy McDonald's expecting the company to move into upscale restaurants, much less day care facilities. It's great Chipotle was a hit for them (which they obviously sold too soon and too cheaply). However for every company that enhance shareholder by moving into new areas I bet there are two that squander corporate resources doing so. I'd rather see them return profits to shareholders ideally via dividend boost, but repurchases also make some sense.

[Running_Man]

I think perhaps I have not adequately done a good job describing the problem and the bubble I see building in corporate debt, and this applies equally to the oil stocks and to MCD.

Mc Donald's in 2008 made 4.2 Billion dollars, in 2014 4.8 Billion dollars. For the past 7 years net income has grown at 2.2 percent annually on average, this is based on actual dollars. On a per share basis thanks to share buy backs net income has grown 6 percent annually. The difference investors and McDonalds thanks to the continual pressure of share buybacks results in a higher PE than the company would deserve otherwise, currently at 19.4 which at 2 percent growth really belongs at a PE of no more than 14 in my view which would value the stock at 70 not 95. As McDonald's continues to participate in this poor use of corporate funds it is wasting the resources it has.

Over the last 7 years McDonalds has earned 34.8 billion dollars and paid 18.1 billion in dividends and 14.7 billion in share buybacks. Leaving McDonalds to fund it's net investment in the actual business with 2 billion dollars over those 7 years, to supplement that it has borrowed 7.1 billion in long term debt in this time and has had net cash investment (Capital Spending less depreciation) of 8 billion with another 1.5 billion or so used for other cash purposes such as inventory, receivables and changes in accruals. Total capital spending in this time frame was 18 billion dollars.

How effective is that investment of 8 billion dollars of cash - for that investment over the past 7 years of 8 billion income increased 500 million annually by the end of 2014. On total capital spending of 18 billion this is a return of 3 percent, McDonald's would do better buying Apple's long term debt with their short term 5 year debt. On the other hand the 320 million invested in Chipotle by Mcdonalds is now worth 22 billion or more than all the dividends paid by McDonalds in the last 7 years and built with capital McDonalds invested to create a national company that now openly mocks and is taking business from the very company that made it possible.

That a company cannot own soda shops, ice cream shops, railroads and banks I think is not true, with the proper management a company can invest in anything but a review of what they do with their investments should be the judgement of investors, not how much of the income they return to investors. And I firmly believe it is management's responsibility to return income to their investors but for a normal corporation I expect 33-40 percent. Over the last 7 years McDonalds has returned 94.5 percent of income to investors through dividends and share buybacks, I just think it is not a prudent use of valuable resources to be such as high percentage. The red flags on this stock are just so high to me and this is a similar problem the oil companies have.

Over the course of time described here as McDonald's has been on their share buy back spree the price has gone roughly from 50-55 dollars to 90-100 dollars, so looking at the share price one would think this has been a good thing for investors, but what this has been is a company overpaying for it's shares which are not worth more than 70 dollars in my estimation. I wonder how much better McDonald's would be if it had used the 14.7 billion in share buybacks to buy stock in Berkshire Hathaway instead and at least give their money to someone who understands investments better than Ronald!

[Brat]

I agree about the corporate debt bubble. I think the big corporate debt risk is oil production. A lot of leveraged producers will fail and default on their debts. Add to that the fact that the economies (housing, service businesses) that are supported by those businesses will fail as well.. there will be a bumpy ride ahead.

Demand for coal is dropping too.

We will be back to the days where to find a geologist you call "waiter".

MCD also has issues with its business model as more and more consumers purchase fast food from the grocery deli counter.

[explanade]

Fast casual is the big thing. There's a Washington Post story about the growth of fast casual at the expense of fast food.

[aja8888]

Thanks, Running_Man for the excellent financial analysis of the McDonald's situation. Here's something from a customer's prospective:

My wife has been sick lately and the other day she asked me to run to the nearby McDonald's to pick up a burger for her rather than have me cook something at home. I usually only buy coffee at McD's as I like their brand and usually do so through the drive thru, of which now most locations have two drive thru isles. (looks like the customer service focus is on the car people and not the counter customers).

Well, I was surprised at the amount of items on the wall menu and tried to order just a burger and got hit with a flurry of questions about which style, off what menu, with or without the "meal", "supersize it", etc. So I just bought two $1 cheeseburgers off the dollar menu and left. No wonder they are losing market share to other shops like 5 Guys, etc. Plus, that dollar menu gotta be killing there revenues...

I think McD's needs to get back to basics and re-evaluate their customer's needs and wants. Maybe the recent management change will look at the menu issues and try to make it simpler and easier for customer's to buy their products.

Different burgers: 16
Different Chicken Sand: 13
Different Wraps: 14

http://www.mcdonalds.com/us/en/food/..._explorer.html

Crazy!

[Hamlet]

A few things. McDonald's made about $5.5 billion per year in 2011,12, and 13, before earnings dropped to $4.8 billion in 2014, so using that one year to extrapolate their return on capital spending is assuming that 2014 is now the new normal rather than a down year (or two). That may end up being correct, but I wouldn't consider it a lock.

At any rate, I would think a poor return on new invested capital would be a reason to encourage dividends and buybacks, not discourage them. They are a mature business. There is little growth opportunity in their existing business and I would prefer that they not branch out into businesses beyond their competency. I'm happy to have the profits returned to me sensibly.

If you feel that MCD is overpriced at a PE 19.4 (I agree it is probably high), do you really think CMG is not at a PE of 55? For all the talk of CMG eating McDonald's lunch, they still have less in revenue than McDonald's has in earnings. There are dozens of companies that have been in CMG's position in the past, and McDonald's is still here. It's easy to grow a restaurant business fast from a small base, but many stumble pretty hard when they get to CMG's size.

I've owned MCD since 2002. At that time, they had issues that make this year's look like nothing real big. They had net income of 900 million or so down from 1.6 billion. Their menu was a mess (anyone else remember the salad shakers?), and they were in a foolish dollar menu war with Burger King. I bought the my shares at 21.5 in September of 2002 with the hope that they would right the ship. They did with a vengeance.

A down year of 4.8 billion doesn't look so bad when twelve years ago the down year was 900 million.

I suspect they will get their house back in order within a year or two.

Quote:

Originally Posted by Running_Man I think perhaps I have not adequately done a good job describing the problem and the bubble I see building in corporate debt, and this applies equally to the oil stocks and to MCD. Mc Donald's in 2008 made 4.2 Billion dollars, in 2014 4.8 Billion dollars. For the past 7 years net income has grown at 2.2 percent annually on average, this is based on actual dollars. On a per share basis thanks to share buy backs net income has grown 6 percent annually. The difference investors and McDonalds thanks to the continual pressure of share buybacks results in a higher PE than the company would deserve otherwise, currently at 19.4 which at 2 percent growth really belongs at a PE of no more than 14 in my view which would value the stock at 70 not 95. As McDonald's continues to participate in this poor use of corporate funds it is wasting the resources it has. Over the last 7 years McDonalds has earned 34.8 billion dollars and paid 18.1 billion in dividends and 14.7 billion in share buybacks. Leaving McDonalds to fund it's net investment in the actual business with 2 billion dollars over those 7 years, to supplement that it has borrowed 7.1 billion in long term debt in this time and has had net cash investment (Capital Spending less depreciation) of 8 billion with another 1.5 billion or so used for other cash purposes such as inventory, receivables and changes in accruals. Total capital spending in this time frame was 18 billion dollars. How effective is that investment of 8 billion dollars of cash - for that investment over the past 7 years of 8 billion income increased 500 million annually by the end of 2014. On total capital spending of 18 billion this is a return of 3 percent, McDonald's would do better buying Apple's long term debt with their short term 5 year debt. On the other hand the 320 million invested in Chipotle by Mcdonalds is now worth 22 billion or more than all the dividends paid by McDonalds in the last 7 years and built with capital McDonalds invested to create a national company that now openly mocks and is taking business from the very company that made it possible. That a company cannot own soda shops, ice cream shops, railroads and banks I think is not true, with the proper management a company can invest in anything but a review of what they do with their investments should be the judgement of investors, not how much of the income they return to investors. And I firmly believe it is management's responsibility to return income to their investors but for a normal corporation I expect 33-40 percent. Over the last 7 years McDonalds has returned 94.5 percent of income to investors through dividends and share buybacks, I just think it is not a prudent use of valuable resources to be such as high percentage. The red flags on this stock are just so high to me and this is a similar problem the oil companies have. Over the course of time described here as McDonald's has been on their share buy back spree the price has gone roughly from 50-55 dollars to 90-100 dollars, so looking at the share price one would think this has been a good thing for investors, but what this has been is a company overpaying for it's shares which are not worth more than 70 dollars in my estimation. I wonder how much better McDonald's would be if it had used the 14.7 billion in share buybacks to buy stock in Berkshire Hathaway instead and at least give their money to someone who understands investments better than Ronald!

[Running_Man]

Quote:

Originally Posted by Hamlet A few things. McDonald's made about $5.5 billion per year in 2011,12, and 13, before earnings dropped to $4.8 billion in 2014, so using that one year to extrapolate their return on capital spending is assuming that 2014 is now the new normal rather than a down year (or two). That may end up being correct, but I wouldn't consider it a lock. At any rate, I would think a poor return on new invested capital would be a reason to encourage dividends and buybacks, not discourage them. They are a mature business. There is little growth opportunity in their existing business and I would prefer that they not branch out into businesses beyond their competency. I'm happy to have the profits returned to me sensibly. If you feel that MCD is overpriced at a PE 19.4 (I agree it is probably high), do you really think CMG is not at a PE of 55? For all the talk of CMG eating McDonald's lunch, they still have less in revenue than McDonald's has in earnings. There are dozens of companies that have been in CMG's position in the past, and McDonald's is still here. It's easy to grow a restaurant business fast from a small base, but many stumble pretty hard when they get to CMG's size. I've owned MCD since 2002. At that time, they had issues that make this year's look like nothing real big. They had net income of 900 million or so down from 1.6 billion. Their menu was a mess (anyone else remember the salad shakers?), and they were in a foolish dollar menu war with Burger King. I bought the my shares at 21.5 in September of 2002 with the hope that they would right the ship. They did with a vengeance. A down year of 4.8 billion doesn't look so bad when twelve years ago the down year was 900 million. I suspect they will get their house back in order within a year or two.

As for CMG their increase in sales from 2008 from 1 billion to 4 billion in 2014 is only about 1 billion behind the increase MCD has had on a 23.7 billion in sales in 2008. And their net income gain over that time frame of 370 million dollars on is not that far behind McDonald's 500 million gain a the main reason CMG went from 50 to 650 over the time McDonald's went from 50 to 95.
Chipotle has done that return of 370 million dollars with a net capital investment of 607 million or a 60 percent return, which is why the PE is so high, although it is a very rich valuation. Chipotle has no debt, and with that extreme flexibility moving forward as consumer tastes evolve, an interesting fact back in 2008 when both stocks were at 50 is that both had book values in the mid teens, Chipotles book value has grown to 66 dollars per share while McDonald's has stayed flat.
Bad day after the market for CMG a very good day for oil and the oil stocks.

[Hamlet]

Hey, Chipotle has done a great job, no doubt, but you're still comparing growth rates off of bases that are an order of magnitude different. Lots of companies grow strong out of the gate. Will Chipolte still be doing great in 10 years? Or will it fall by the wayside like a large percentage or restaurant companies do?

How big do you think Chipotle is going to get? That PE of 55 is going to take a massive amount of fast growth to justify. Although a little less will be needed tomorrow when the stock opens.

I'm not sure comparing book values of a company that funds massive dividends and buybacks and one that still mostly building out new restaurants really makes much sense. Would you like MCD more if it had kept all that cash sitting around?

On the plus side, CMG just authorized expanding their stock buyback, so they will spend $200 million of that book value reducing their share count by 1%.

I think I'll stick with MCD. We'll see how things look in 2025.

Quote:

Originally Posted by Running_Man As for CMG their increase in sales from 2008 from 1 billion to 4 billion in 2014 is only about 1 billion behind the increase MCD has had on a 23.7 billion in sales in 2008. And their net income gain over that time frame of 370 million dollars on is not that far behind McDonald's 500 million gain a the main reason CMG went from 50 to 650 over the time McDonald's went from 50 to 95. Chipotle has done that return of 370 million dollars with a net capital investment of 607 million or a 60 percent return, which is why the PE is so high, although it is a very rich valuation. Chipotle has no debt, and with that extreme flexibility moving forward as consumer tastes evolve, an interesting fact back in 2008 when both stocks were at 50 is that both had book values in the mid teens, Chipotles book value has grown to 66 dollars per share while McDonald's has stayed flat. Bad day after the market for CMG a very good day for oil and the oil stocks.

[NoiseBoy]

Quote:

Originally Posted by Jmlstocks I have to ask: Why would you hate a company that buys its shares back-that's a good thing if you're a shareholder

The megacorp that I work for is a cyclical business. For the past two years they've been buying back stock, and some of that has been financed with new debt, I believe. Today, the stock is trading 30% off of its 52 week high and it's 15% below where it was 2 years ago. As a long term shareholder I don't see how I have benefited in any way from the billions that have been spent to, in my opinion, prop up the stock price. I did see executives filing SEC forms to sell shares when the price was over $100 a share. I'm not claiming insider trading or anything, just that they had incentives to unload, and did so at the right time. As a long term shareholder, I'd rather have dividends, more R&D spending, or even higher pay to the employees than borrowing to buy back shares.

[Empresario]

Buying on bad news can be profitable. Or, one can look foolish. Be careful!

Buying Exxon after the Valdez spill worked out pretty well for me. But, I did not believe in BP after the Gulf of Mexico spill.


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