The Stock Buyback Libel. The Buyback King That Beat Amazon. And a Buyback Stock Call – Pulte Homes.

Oct 03, 2018 by Gary Gordon

Let's start off with a dramatic chart to grab your attention, which compares the stock price history of Amazon with Company X and a Company X competitor:

Source: Yahoo Finance

Does the name NVR mean anything to you?  Probably not.  A Google search reveals a possibility – “network video recorder”, something used in security cameras.  Sounds sexy enough to possibly beat out Amazon.  But wrong.  NVR is a regional homebuilder.

A homebuilder?  A boring old economy homebuilder beat out Amazon over the past 18 years?   OK, admittedly measuring from January, 2000, the peak of the internet bubble, is somewhat misleading.  But still pretty cool.  And NVR also slaughtered Lennar, a well-respected homebuilding competitor.  How?

Clearly NVR is excellent at its craft, but critical to its stock success has been aggressive share repurchases.  In 2000, NVR had over 10 million shares outstanding.  Today it has 4 million, or a 60% decline.  In fact, NVR used more than all of its earnings since 2000 to buy back stock.  As a result, instead of NVR’s 2018 earnings per share equaling about $70, it will be over $200.

The buyback libel.

NVR has shown that active share buybacks can substantially improve stock prices.  So imagine my dismay when I ran across this in Monday morning’s (September 24) Wall Street Journal:

“Buybacks Dress Up Profits…Stock buybacks make profits appear better by boosting per-share earnings, a metric investors frequently use to justify a company’s stock price.”

First off, let’s zoom in on this phrase from the supposed business paper of record (my formatting): “per-share earnings, a metric investors frequently use to justify a company’s stock price.”  Per share earnings “justifies” a stock price?  Isn’t that precisely a company’s capitalist goal?  To increase the earnings attributed to my share of stock?  What alternatives would the author of this story suggest to justify stock prices?  Possibly the new paradigm of sales growth, however unprofitable.  Or perhaps the author is a plant of the Communist Party and favors a carbon footprint measure or, god forbid, less income inequality. 

The WSJ article went on to add this, suggesting the author isn’t completely pinko:

“Buybacks reduce a company’s share count, spreading the profits across fewer shares. As a result, companies can report a bigger percentage increase in per-share earnings than the profit results alone may show.”

That’s exactly the advantage of a stock buyback for investors.  Suppose that you and four friends buy a restaurant, and that its kale-free menu creates a wild success, earning the group a cool $1 million in income a year.  You and your partners each are entitled to 20% of that haul, or $200,000 a year.  Now one of the partners wants to sell her share back to the four remaining partners.  The restaurant still churns out the $1 million of profits, but now you have a claim on 25% of them, or $250,000 a year.  That seems like a better number, doesn’t it? 

But, hopefully you are silently saying to me right about now, “what is the price you paid to gain the right to the extra $50,000 a year?  If it was $200,000, you got a sweet deal.  If it was $2 million, a pretty dumb move”.  So buybacks can be groovy (yes, I’m a Baby Boomer) if the buyback price is right.

Buying at the right price – Pulte Homes

Pulte (stock symbol PHM) is a long-time competitor of NVR, but a relatively recent disciple of its buyback strategy.  Pulte, like its peer homebuilders, suffered greatly in the wake of the housing bust.  But by 2012 it started making money again, and by 2014 it started buying back its stock.  Pulte had 386 million shares outstanding in 2013.  By its last quarterly earnings report (Q2 ’18) it had only 287 million, an impressive 26% reduction.  Management certainly seems committed to buybacks as a way to create shareholder value, which is a good thing for, well, shareholders.

Pulte’s buyback story is getting better.  As I write this, the stock is at $24.68.  Stock analysts polled by Yahoo Finance expect Pulte’s EPS to be $3.75 this year and $3.85 next year.  So Pulte can buy back its stock at a dazzlingly low 7 times EPS, which is well less than half the valuation of the average stock.  If management uses only half of its expected $1.5 billion of profits through the end of 2019 to buy stock at the current price, it can reduce its shares outstanding by another 30 million, or 10%.  And a recent UBS report says that Pulte plans to sell excess land that it holds.  If so, even more cash to buy back its seemingly very cheap shares. 

Why is the stock so cheap…

…Reflecting its nearly $4 in EPS and its intelligent capital management?  I believe because investors remain afraid of the housing market, a full decade after the bust.  And indeed the housing market today has a number of unique characteristics that make it harder than usual to analyze.  But I’ll stick to my buyback theme in this blog post and save the housing story for the next one.

Wrapping up…

- Stock buybacks can add significant value to investors if done consistently and at the right prices.

- Pulte Homes seems like an excellent way to play this theme.

- For better or worse, I own the stock and am inclined to buy more.