Most investors think stock prices always follow earnings. So they obsess over profits – and the sales growth needed to drive them higher.
They’re partly right – but they’re more wrong than right. Their first-level thinking is missing a couple of small but critical nuances.
First, stock prices are quoted per share. When you buy a stock, you’re not buying the entire company. Instead, you’re buying a very small percentage as represented by your shares. So as a shareholder, it’s actually irrelevant to you whether or not your company’s earnings go up in absolute terms. What matters to you is that its earnings per share (EPS) go up year-after-year.
And second, while you may need sales growth to drive perpetual earnings growth (because cost cutting has its limits), you don’t actually need sales growth for EPS growth.
If you don’t believe me, then take a look at the following yearly revenue chart. Tell me if you’d buy this company knowing that its sales growth was about to flatten like this entering 2013:
Would You Buy This Company Here?
If you answered “no” then you actually missed out on 41% stock gains.
41% Stock Returns Despite Flat Sales
This trick is nothing new for our shareholder enrichment expert General Mills (GIS). The company has turned low single-digit sales growth into double-digit returns for decades:
General Mills Manufactures Consistent Double-Digit Returns
How’s it done this with steady but saturated staples like Cheerios and Green Giant frozen vegetables? Simple – it bought back a lot of its own shares. Take a look at this chart – it’s why you wanted to buy GIS to start 2013:
GIS Bought Back 7% of Its Outstanding Shares in Two Years
General Mills repurchased 7% of its stock from 2013-2015. This helped propel EPS growth of 20% over the same time period – and a stock price that rallied 41%. Not bad for a stock that most investors believe is about as bland as its new “ancient grains” version of Cheerios.
So how do you find the next boring stock set to quietly deliver double-digit gains with buybacks? It’s a simple formula:
- Find a board that recently approved a big share repurchase.
- And make sure the stock is cheap.
The good news is that plenty of companies are buying back their own shares. Over the past twelve months, S&P 500 companies bought back over $555 billion of their own stock – or 2.8% of aggregate shares outstanding.
Unfortunately not all of these buys were smart ones. There are more expensive stocks than cheap ones these days. That includes GIS, which is as pricey as it’s been in the last five years with respect to earnings, sales, and cash flow.
But I do like two companies that are buying back their respective shares like they’re going out of style. And they’re doing so at cheap valuations – so that shareholders are all-but-guaranteed double-digit returns for a few years. Click here to get the names of both companies AND learn about all THREE “invisible” payout loopholes we’re using.
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