Look at Companies that Lower Share Count

11/13/2013 12:00 pm EST


Norm Rothery

Founder, StingyInvestor.com

Don't follow the investors who are solely interested in a company's share price, writes Norman Rothery of The Globe and Mail, or you might miss out on companies producing better results for their shareholders, such as this one.

Most investors focus on a company's share price. They should spend more time looking at a related question—how many shares the company has, and whether that number is growing or shrinking.

The answer can be a valuable guide to which management teams are doing the best job at creating value for shareholders.

For starters, a look at share growth can help you spot greedy CEOs who are benefiting from stock options at the expense of investors.

The problem occurs when a company grants options in bulk to its key executives when times are tough and its share price is depressed. Of course, that's exactly when firms should be doing the opposite—buying back their cheap stock instead of issuing it.

When prices improve, executives cash out the options, which waters down existing shareholders. Some companies try to mop up the dilution by buying back stock at the new, elevated prices, but that only compounds the problem. By doing so, the company destroys shareholder value by selling its stock low and buying it high.

Stock options represent just one form of dilution that can hurt investors. Shareholders should also be wary of companies that use their shares as currency in acquisitions. History shows that large stock-based deals have a habit of disappointing. On the other hand, small cash-based transactions tend to work out reasonably well.

Richard Tortoriello examined the impact of share growth in his book Quantitative Strategies for Achieving Alpha. In one study, he considered how investors fared when they bought stocks each year based on the degree to which each company had grown—or shrunk—its number of shares over the prior year.

The 20% of companies that lowered their share counts the most, outperformed the market by an average of 3.1% annually from 1988 to 2007. On the other hand, the 20% that added the most shares, trailed the market by 5.2% annually over the same period.

For these reasons, I like to focus on companies that reduce the number of shares they have outstanding—provided they do so in a responsible manner. There aren't many of them out there, but they tend to perform well.

I happened upon Seaboard Corp. (SEB) a few years ago, when I was looking for stocks that buy back their shares. It's not the most aggressive re-purchaser in the market, but it has reduced its share count by 20% since the turn of the century.

Seaboard runs a sprawling agricultural and transportation conglomerate out of its headquarters in Shawnee Mission, Kansas. You may have devoured one of its turkeys this Thanksgiving because it owns a 50% interest in Butterball LLC. But Seaboard's pork business generated the bulk of its profits in 2012. It also earned money from commodity trading, sugar, power, and shipping.

Seaboard is a family-controlled firm. That can be problematic in cases where families put their interests ahead of shareholders. Seaboard, however, has proven to be reasonably friendly to outside investors.

Last year, for instance, the firm paid out a special dividend, equivalent to what it was due to pay from 2013 to 2016, to cushion its shareholders from a pending tax hike.

(Of course, it's easy to be shareholder-friendly when you're the major shareholder.)

More importantly, the company has a superb long-term growth record. It earned just over $25 (US) per share in 2003, and it should rake in almost $200 per share this year, according to S&P Capital IQ. In addition, the firm grew its tangible book value per share by an average of 17.4% annually over the past ten years, which is a record that very few companies can come close to matching.

Despite its outsized growth rate, the company trades at relatively modest levels. Its stock can be had for 1.4 times tangible book value, which is well below its peak multiple near three. It might not be as cheap as it was during the crash of 2008, but it still has lots of room for expansion.

When you next sit down to dinner, give Seaboard a second thought.

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