The iron law of investing is that every stock is a claim on a future stream of cash flows. It follows, then, that the price you pay and the return you get are two sides of a seesaw. As your purchase price decreases relative to the future cash flows, your return on investment goes up.
Plasma products maker CSL (ASX: CSL) is Australia’s largest healthcare company and has barely put a foot wrong in 10 years. Those who bought the stock when Share Advisor first upgraded it on 20 Jan 2010 (Long Term Buy – $31.30) have earned a 236% return including dividends.
But with the share price up 33% over the past year alone, it’s not the bargain it once was. Any investor wanting to buy CSL today should hope the stock tumbles so their purchase price is lower.
However, long-term investors who already own the stock would also be better off if the share price were to fall.
CSL has been consistently repurchasing its own stock since the peak of the financial crisis in 2009. The company has spent more than $6bn buying back its shares, reducing the share count by 22% and creating significant value for shareholders. The current share price is now nearly double CSL's average purchase price of $48.
Let’s imagine the company announces another $1bn dollar buy-back at the annual result. If CSL’s stock averages, say, $95 over the next year, the company will acquire roughly 10.5m shares for its $1bn. There would then be around 463.3m shares outstanding.
If the price were to crash back to its 2011 low of $27, however, the company could repurchase 37.0m shares and investors would only have to split the pie 436.8m ways. Long-term shareholders would own around 6% more of the company than they otherwise would, without any additional investment themselves.
Rio Tinto (ASX: RIO), Wesfarmers (ASX: WES) and Telstra (ASX: TLS) have also repurchased stock recently, and they won’t be the last. If you’re going to be a net buyer of stocks, either directly or because a company is repurchasing shares, high prices lessen your future returns. When the next big dip arrives, it’s time to cheer.
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