Author Topic: Should Repurchases be counted in FCF/yield per share?  (Read 17308 times)

Palantir

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Should Repurchases be counted in FCF/yield per share?
« on: October 03, 2013, 10:06:46 AM »
In the thread on Accenture PLC, one member stated a valuation method where the expected return on investment in a share = FCF Yield + Growth.

I stated that if you were to do it on a per-share basis, then you have to exclude the share repurchases from the FCF Yield as they do not flow to stockholders and are reinvested in the firm in order to increase future FCF/share, and counting them in FCF Yield would be double counting as it is already reflected in the rising earnings yield.

However, two other posters disagreed, what's your take?

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/accenture-plc-acn/msg135032/#msg135032
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Munger_Disciple

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #1 on: October 03, 2013, 10:52:29 AM »
Yes, you have to exclude share repurchases from FCF yield because the share repurchases contribute to the FCF per share growth. If not, you are double counting the effect of share repurchases.

Palantir

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #2 on: October 08, 2013, 01:01:17 PM »
I think this is relevant especially for IBM. It has strong growth per share, but it is pretty much using up all of its FCF in buybacks, so your actual FCF/s is pretty low, and if they ever reduce buybacks to increase cash flow, then growth will also come down.


http://www3.nd.edu/~scorwin/fin70610/Common%20DCF%20Errors_LeggMason.pdf
Quote
7.
Double counting.
Models should not count a dollar of value (or liability) more than once.
Unwittingly, DCF models often double count the same source of value.
Take share repurchase, for instance. Companies generating strong free cash flow often have a
record of buying back stock that is likely to continue. Analysts, recognizing both a proclivity
toward buybacks and strong cash flow, sometimes build buybacks into their models by assuming
the company uses free cash flow to shrink shares outstanding over time. This double counts
because the model values the cash flow (once) and the model uses the same cash flow to reduce
shares outstanding (twice). This error of double-counting leaves aside the analytical challenge of
judging the future stock price (the only way to properly determine how much stock a company
might buy).
Another less frequent example of double counting involves the practice of including interest
income in the cash flow calculation and adding the cash balance to corporate value. Alternatively,
some analysts subtract financing costs from cash flow and then deduct debt from corporate value
to come up with shareholder value.
« Last Edit: October 08, 2013, 01:02:57 PM by Palantir »
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ERICOPOLY

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #3 on: October 08, 2013, 03:45:32 PM »
as they do not flow to stockholders and are reinvested in the firm

I think you've got it backwards.  Return of capital by definition flows to shareholders, it's not a reinvestment in the firm.

zarley

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #4 on: October 08, 2013, 03:54:16 PM »
For me it depends.  If the repurchases fully go to reduce share count, then I ignore that (don't subtract it from operating cash flow).  If the repurchases are just a way of masking the dillutive effects of stock options (e.g., a lot of tech stocks) then I consider it a cost to shareholders and so I will adjust my FCF estimates as a result.

Palantir

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #5 on: October 08, 2013, 04:24:28 PM »
as they do not flow to stockholders and are reinvested in the firm

I think you've got it backwards.  Return of capital by definition flows to shareholders, it's not a reinvestment in the firm.

It doesn't flow to shareholders. When a firm produces cash from operations it goes to the firm's equity, if it's used to buyback, it is an outflow that continuing shareholders do not see.
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racemize

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #6 on: October 08, 2013, 04:27:37 PM »
Seems like we should just use Buffett's "owner earnings" which is the amount of cash left over after taking care of operational costs.  Everything after that is an allocation decision.

Now you might be tempted to keep repurchases used to keep the share count steady as part of the cash required to keep the business going, as a possibility.

TwoCitiesCapital

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #7 on: October 08, 2013, 04:30:17 PM »
as they do not flow to stockholders and are reinvested in the firm

I think you've got it backwards.  Return of capital by definition flows to shareholders, it's not a reinvestment in the firm.

It doesn't flow to shareholders. When a firm produces cash from operations it goes to the firm's equity, if it's used to buyback, it is an outflow that continuing shareholders do not see.

I disagree. It's seen be whichever shareholders are directly selling the shares to the company. The remaining shareholders see no cash, but they see an increase in their % ownership of equity and cash flows and (hopefully) and increased stock price based on P/E and P/FCF multiples.

Palantir

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #8 on: October 08, 2013, 04:31:15 PM »
^ You could do that I suppose, but then I think two problems arise: 1) there's no way to account for bad capital allocation decisions and 2) you will have to reduce FCF/share growth to reflect the fact that the model won't have buybacks.
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Palantir

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Re: Should Repurchases be counted in FCF/yield per share?
« Reply #9 on: October 08, 2013, 04:34:32 PM »

I disagree. It's seen be whichever shareholders are directly selling the shares to the company. The remaining shareholders see no cash, but they see an increase in their % ownership of equity and cash flows and (hopefully) and increased stock price based on P/E and P/FCF multiples.

Yes, but the "increase in ownership" is a different component of value from "cash flow". As you noted, the remaining shareholders see an increase in cash flow, but that cash flow only came about because remaining shareholders gave up current period cash flows to do so.

 In a DCF, you are only valuing the company based on the cash on hand + discounted future cash flows, the increase in ownership, which is true, would not be applicable.
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