There are two primary ways companies grow value per share: (1) increasing the value of operations, and (2) decreasing the share count over time through repurchases at prices at or below intrinsic value. Companies that do either one of these tend to outperform the market over a long period of time. However, companies that increase the value of the business and decrease the share count tend to do the best.
Cannibals
The chart below shows the shares outstanding for each company over the last ten years. International Business Machines Corp. (NYSE:IBM) and McDonald’s Corporation (NYSE:MCD) are charted using the left axis, while Advance Auto Parts, Inc. (NYSE:AAP) is charted on the right axis.
All three companies have steadily repurchased shares regardless of price or market environment. Although this is not the most efficient, or even shareholder-friendly, method of share repurchases (shareholders would prefer them to purchase a large amount of shares only when the stock price is below intrinsic value) the repurchases average out to a net benefit to shareholders.
By the end of the decade, shareholders will own significantly more of these companies than they originally paid for. Even if McDonald’s Corporation (NYSE:MCD) stopped growing, value per share would still increase due to share repurchases. However, when combined with growth in the value of operations, share repurchases compound the increase in shareholder value.
Improving operations
The reason that constant share repurchases average out to a net benefit for each of these companies is that their operations are growing, not deteriorating. Although it is still possible that the shares are overvalued, the growth in the value of operations will eventually negate value-destroying repurchases.
Over the last decade, all three companies have grown free cash flow by a meaningful amount — and earnings by an even higher amount.
The exact amount of growth is not as important as the fact that the number is growing. Advance Auto Parts, Inc. (NYSE:AAP), International Business Machines Corp. (NYSE:IBM), and McDonald’s Corporation (NYSE:MCD) are all improving, not deteriorating.
Advance Auto Parts, Inc. (NYSE:AAP) is already the most efficient auto parts supplier in the do-it-yourself market, and it has significant growth opportunities in the commercial market.
International Business Machines Corp. (NYSE:IBM) is long past its high-growth days, but its customer relationships are so deep that it is virtually assured to continue increasing cash flows for the foreseeable future.
McDonald’s Corporation (NYSE:MCD) is the leading fast food chain with the most recognizable name in the industry; its growth prospects in China make it likely that profits will continue to grow at a steady clip over the next decade.
Compounding value per share
When taken together, free cash flow growth and share repurchases compound shareholder value at a high rate. Each company has increased its free cash flow per share by a significant amount as a direct result of share repurchases. As a result, these companies are worth far more than they would be had management simply paid out the cash in a dividend.
Bottom line
Constant share repurchases are nearly always good for shareholders. When combined with growing earnings, share repurchases compound shareholder value at a much higher rate than could otherwise be achieved. Therefore, investors who buy growing companies that habitually repurchase shares — and hold on for the long run — will likely be rewarded by outsized returns.
The article These Companies Grow Shareholder Value Better Than All Others originally appeared on Fool.com and is written by Ted Cooper.
Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends McDonald’s. The Motley Fool owns shares of International Business Machines. and McDonald’s. Ted is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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