Can Share Buybacks Benefit Major Shareholders Disproportionately?

Last month, we had Wal-Mart (WMT) announcing its quarterly results. The results were fine, and it does seem like the company is becoming a formidable competitor to Amazon. 

Unfortunately Wal-Mart has been unable to grow earnings per share over the past five years. As a result, the company has kept raising dividends at a very slow pace. Given the low yield, the high P/E ratio, I do not believe that Wal-Mart is a good value today. I expect a slow dividend growth from the likes of AT&T and Verizon, which at least have an above average yield. I do not expect a slow rate of dividend growth from a low yielder with a high P/E ratio like Wal-Mart. 

While management does not control the dividend yield, they do control where the money gets allocated. Management is investing heavily in the e-commerce, and integrating the online and offline shopping experience into a seemingly integrated experience. It is quite possible that Wal-Mart a decade from now will earn more money, and be more valuable.

As part of their capital allocation decisions however, management has continued with buying back shares. In general, companies buy shares when they have too much extra cash on hand, but do not want to commit to paying a higher dividend. Shareholders typically expect that dividend payments are kept and gradually increased. If a dividend is increased, and then cut, it makes the company’s situation seem dire. It also makes management look like they are doing a poor job. 

If management wants to distribute those excess profits to shareholders but wants to keep flexibility in the distribution, they can either do a share buyback or a special dividend. Corporations these days tend to prefer share buybacks. Most commentary in the media seems very biased in favor of buybacks, and somewhat opposed to dividends. As a result, the common message sold to ordinary shareholders is that dividends and share buybacks are the same thing, when in reality they offer vastly different outcomes.

The problems with buybacks are that:

1) Management teams seldom do any analysis on whether they are getting a good value for their money when buying back stock

2) Management teams can announce a buyback, but never execute it

3) Buybacks may mask the dilutive effects of stock options on shares outstanding ( executive compensation in stock)

4) More often than not, companies have excess cashflows when their shares are overvalued, hence they tend to destroy value. Companies tend to halt buybacks when we have economic uncertainty, but share prices are low.

5) A dividend treats all shareholders fairly, while share buybacks do not treat all shareholders fairly

After reviewing Wal-Mart’s proxy statements, against the trend in shares outstanding, I came up with another problem with buybacks.

I found that the Walton family, either directly or through trusts, owns more than 50% of the company stock. Just a few short years ago, their ownership percentage was lower.

As a result of share buybacks, Wal-Mart is essentially using your shareholder money to increase the percentage ownerships of the Walton family.

The risk that I am seeing is that management runs Wal-Mart for the benefit of the Waltons. Buybacks have disproportionately helped the Walton family increase its ownerships from 40% to 50%. This is a risk that many investors rarely think about in general, when thinking about buybacks versus dividends.

Back in 2007, the Walton clan owned roughly 41% of shares outstanding:

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Disclaimer: I am not a licensed investment adviser, and I am not providing you with individual investment advice on this site. Please consult with an investment professional before you invest ...

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