Saturday, June 28, 2008

Free cash flow and share buybacks

I was looking through the cash flow statements of Pepsi for the last 10-years at the morningstar’s website and I saw that Pepsi has been buying back its stock consistently for the last 10 years.

I summed up all dollars Pepsi spent on stock buybacks for the last 10-years. The total was around $16 Billion dollars. Wow! Pepsi spent $16 Billion dollars to buyback its stock in the last 10-years. After calculating this, I wanted to see how much the total share count has decreased over the last decade. To see this, I switched to the income statements on the Morningstar’s website. There I saw that the total share count has not decreased at all. Instead it has gone up about 80 million shares in the last decade. In 1998, Pepsi had about 1.52 Billion shares outstanding, and in 2008 Pepsi has about 1.60 Billion shares outstanding.

So, where did $16 Billion spent on the share buybacks go? If a company spends $16 Billion of its free-cash flow to buyback shares then share count has to go down, doesn’t it?

But, my guess is that Pepsi is simply buying its own stock to neutralize the dilution created when the executives and employees exercise the stock options. So, in other words the share buyback is a systematic transfer of wealth from shareholders to employees and executives.

I am sure many company’s cash flow statements will show this type of shenanigans. I will try to post more cases as I find them because I am currently going through a lot of financial statements and I am sure I will come across more of this.

From now on, when I will calculate free-cash flow I will deduct the amount spent on share repurchases from the free-cash flow if the number of shares do not go down from the year before. How does that sound?

Datasources:
http://quicktake.morningstar.com/StockNet/cashflow10.aspx?Country=USA&Symbol=PEP
http://quicktake.morningstar.com/StockNet/income10.aspx?Country=USA&Symbol=PEP

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