Companies that generate significant amounts of free cash flow often like to return that cash to their shareholders by way of share repurchase programs. By buying back their own shares, companies reduce the total number of shares outstanding. This can benefit shareholders because fewer outstanding shares means that earnings per share goes up for a given level of net income.
Microsoft (MSFT -1.32%) has been fairly aggressive about buying back its own stock over the years -- something that has, in my view, likely delivered real value to the company's shareholders.
Microsoft's headquarters. Image source: Microsoft.
Let's take a closer look at how effective Microsoft's share repurchase activities have been over the last 10 years or so and what the future of the company's repurchase program could look like.
Steady share count decrease
At the end of Microsoft's fiscal year 2008, the company had 9.38 billion diluted shares outstanding. By the end of the third quarter of its fiscal year 2018, the company's diluted share count stood at 7.794 billion .
That's a reduction of roughly 1.5 billion shares which, as of writing, are worth around $160 billion.
How much value did this share count reduction create for stockholders, then? To try to estimate that, let's pretend that Microsoft didn't aggressively buy back the shares that it did over the years and instead simply bought back enough stock to keep the share count flat at 9.38 billion. Let's also assume that the company's market capitalization stayed the same.
Under those assumptions, Microsoft stock -- which recently closed at $101.63 per share -- would be worth just $84.45 per share, or 16.9% lower than where the stock currently trades.
What's next for Microsoft's stock buyback?
Last quarter, Microsoft said that it had "returned $6.3 billion to shareholders in the form of dividends and share repurchases," a figure that the company claimed was a 37% increase from the same period a year ago.
Of that $6.3 billion that Microsoft gave back to its stockholders, $3.78 billion was used to repurchase shares while $3.23 billion was given back in the form of a cash dividend. Interestingly, while Microsoft's total dividend payments were up $220 million, or 7.3%, from the prior year, the company's share repurchase activity surged more than 80%.
Microsoft's increased focus on share repurchases isn't a surprise; recent changes in the U.S. tax code have made it easier for corporations to repatriate cash held overseas to be used on things like share buybacks. Moreover, the new lowered U.S. corporate tax rate has been reduced substantially, which should boost companies' net income and should make it easier for them to return cash to stockholders.
However, I don't want to give the impression that Microsoft's interest in share repurchases is driven solely by tax reform; the company's business performance seems to be on the upswing, as well:
MSFT Revenue (TTM) data by YCharts.
Should Microsoft's business continue to see increases in both revenue and operating income, I have little doubt that the company will, at a minimum, increase both its dividend and its share repurchase activity commensurate with the improvement in its business performance. That should mean both fatter dividends and bigger share repurchases (which would mean higher earnings per share) in the years ahead.
