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One Thing the Blue Chips Can Do Better For Investors

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A share buyback, for the uninitiated, is the act of a company buying back its own shares, either through the open market, or through pre-arranged transactions.

It can be a great way to return value for shareholders provided the buybacks are done when a company’s shares are undervalued. Every company has many choices with which it can allocate the capital it has in its coffers. With responsible management, each dollar of capital that’s allocated for any investment would have been carefully thought through for its potential return.

On that front, when a company’s shares are undervalued, and when other acquisitions or expansions gives lower rates of return, a share buyback makes perfect sense for shareholders.

In addition, as I’ve written previously:

If companies are buying back their own stock and reducing the outstanding share count substantially, existing shareholders’ stake in the business becomes more valuable. A company earning $10m with 1m shares will earn $10 per share. If the share count’s reduced to 0.8m, each share will be entitled to $12.50 worth of profit, enhancing the value of the existing shares.

Henry Singleton, an iconoclastic chief executive from the American conglomerate Teledyne was a master at using buybacks to return value to shareholders. And under him, Teledyne’s shares rose a stupendous 20.4% a year from May 1963 to 21 June 1990, turning each dollar into $150 in that period.

Unfortunately, in our local share market, especially among the current crop of blue chips within the Straits Times Index (SGX: ^STI), there does not seem to be any that has done any sustained bouts of buybacks since the start of 2008.

I picked 2008 for a very good reason: It was the start of the Great Financial Crisis and throughout the year, most shares found themselves sliding lower and lower, with the Straits Times Index eventually bottoming-out at 1,456 points on 10 March 2009 at a trailing price-to-earnings (PE) ratio of around 6.

With the Straits Times Index at such a low valuation at that time, it would also mean that most of its 30 constituents would likely have been available at a great value.

But as it turns out, among the current crop of index-constituents (for those that were publicly-listed entities back then), only five shares had reported lower share-counts at the end of 2009 as compared to at the end of 2007: Singapore Airlines (SGX: C6L), Hongkong Land Holdings (SGX: H78), United Overseas Bank (SGX: U11). SembCorp Marine (SGX: S51), and Sembcorp Industries (SGX: U96).

Company Share count: end of financial year 2007 Share count: end of financial year 2009 % Change
SIA 1246.8m 1182.6m -5.15%
Hongkong Land 2295.2m 2249.3m -2.00%
UOB 1512.2m 1506.0m -0.41%
SembCorp Marine 2070.9m 2064.3m -0.32%
SembCorp Industries 1783.8m 1780.2m -0.20%

Source: S&P Capital IQ

So while there have been declines in share count for those five companies, the magnitude has been tiny for the rest, except for Singapore Airlines. You can’t move the needle that way for the other four companies.

Foolish Bottom Line

American billionaire investor Warren Buffett once said, “Short of a polygraph, the best sign of a shareholder oriented management – assuming its stock is undervalued – is repurchases. A polygraph proxy, that’s what it is.”

I’m certainly not suggesting that the managements of the blue chips are not shareholder friendly. But when shares are cheap, as it was during the Great Financial Crisis, perhaps more could be done by management for shareholders by buying back shares.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.