An interesting look at share dilution and share buybacks

I did some homework yesterday to review what the number of outstanding shares looks like for each of the companies that I hold. As a background, companies usually buy back shares to reduce the number of outstanding shares on the open market. Companies are measured by earnings per share (EPS). This is done by dividing total earnings of the company by the total number of shares on the market. With a lower share count, the EPS goes higher. Also with a lower share count, the company does not have to dish out so much cash to pay for all those quarterly dividends.For example Coca Cola pays 37 cents per dividend every quarter. If they bought back 10,000,000 shares back for $460,000,000 then they would be able to save paying $14.8M a year in dividends.

Companies can also dilute shares. Sometimes a company needs to finance a large acquisition. Or maybe the company needs more money for various reasons to operate. Diluting shares is bad for investors unless the money spent is able to add more to the earnings relative to how much dilution occurs. Usually debt heavy industries such as real estate and utilties dilute shares to fund expansion. With each new share sold on the open market, the amount of dividend dollars a company needs to pay increases. Every new share needs to be paid the dividend making the dividend burden even bigger.

I get my share data from Morningstar. I look at a 5 year window up to 2016 and just divide the percentage decline or increase over that 5 year period to get a rough estimate of how much the company on average changes the number of shares.

The example above shows Illinois Tool Works (ITW). In my portfolio this company has been the best at reducing share count over a 5 year window and they are also a very well performing dividend aristocrat with rising earnings per share. The share count at the end of 2016 was 357M and it was only 495M 5 years earlier. This is a very impressive decrease of 5.5-6% a year.

I did this investigation for all of my holdings. I noticed that a lot of my best portfolio performers have very nice share count decreases. These include ITW, Home Depot (HD), Visa (V), MasterCard (MA), Ross Stores (ROST), and 3M (MMM). Most of my normal "C" Corps have made an attempt to reduce or at least keep the number of shares flat. Keep in mind companies do pay their execs and employees stock for bonuses and incentives. Companies have to keep buying these stock back in order to avoid diluting the share base.

Name	Ticker	Sector	ShareCnt5yr
Illinois Tool Works Inc.	ITW	Industrial	-6%
Home Depot Inc	HD	Discret	-4%
McDonald's Corporation	MCD	Discret	-4%
Visa Inc	V	Financial	-3%
Mastercard Inc	MA	Financial	-3%
Ross Stores Inc	ROST	Discret	-3%
3M Co	MMM	Industrial	-3%
TJX Companies Inc	TJX	Discret	-3%
Bard (C.R.) Inc	BCR	Health	-3%
Philip Morris International Inc	PM	Staples	-2%
PepsiCo	PEP	Staples	-2%
General Mills, Inc.	GIS	Staples	-2%
Kimberly-Clark	KMB	Staples	-2%
Automatic Data Proc, Inc	ADP	Tech	-2%
Church & Dwight	CHD	Staples	-2%
Colgate-Palmolive Co	CL	Staples	-2%
Altria Group Inc	MO	Staples	-1%
McCormick & Company	MKC	Staples	-1%
Procter & Gamble Co	PG	Staples	-1%
The Coca-Cola Co	KO	Staples	-1%
Stryker Corporation	SYK	Health	-1%
Abbott Laboratories	ABT	Health	-1%
Johnson & Johnson	JNJ	Health	0%
Becton Dickinson and Co	BDX	Health	0%
Starbucks Corporation	SBUX	Discret	0%
Clorox Co	CLX	Staples	0%
Hormel Foods Corporation	HRL	Staples	0%
Air Products & Chemicals, Inc	APD	Materials	0%
AT&T Inc	T	Telecom	1%
Xcel Energy Inc	XEL	Utilities	1%
Dominion Resources, Inc	D	Utilities	1%
The J. M. Smucker Company	SJM	Staples	1%
Aqua America Inc	WTR	Utilities	1%
NextEra Energy Inc	NEE	Utilities	2%
Southern Co	SO	Utilities	2%
Federal Realty Investment Trust	FRT	REIT	3%
WEC Energy Group, Inc.	WEC	Utilities	7%
Realty Income Corp	O	REIT	40%
Kraft Heinz Co	KHC	Staples	N/A
Medtronic plc	MDT	Health	N/A

Some companies are the product of mergers and acquisitions so I was not able to really get a good idea of share count growth or decline. The Utilties and REIT space are the worst sectors in terms of minimizing share count. I don't own any MLPs but MLPs also operate similarly. Realty Income (O) has increased the number of shares drastically from 126M in 2011 to 256M in 2016. This is basically a doubling of the number of shares in just 5 years. REITs need to make public offerings to acquire cash for purchasing additional properties. REITs pay the large majority of their earnings back to the share holders, which means they cannot keep a lot of the money they earn. Diluting the share base is the way they can fund their expansion. If the expansion purchases add more to the bottom line compared to the dilution of shares, then the overall company performance will continue increasing. This can be seen in well managed REITs like FRT and O. However, the dilution of shares still concerns me which is why I do not have a super large position in REITs.

Although share buybacks are important. It is not the panacea for increasing company earnings per share. I would rather see executives invest in the company organically instead of financially engineering the company's earning statistics. Buying back stock can only work so much but one must innovate and keep up with the competition by having good products and services. That requires investment back into the company and buying back shares is only a way to "cheat" in the short term. Additionally, companies oftentimes buy shares back at market highs since that is when the company is doing their best and spare cash is abundant. That money might have been better used in dividends or company reinvestment or acquisitions.