Buybacks only add shareholder value to the extent they are accretive to adjusted book value (ABV) per share. I usually use tangible book value as my ABV, but if one feels confident of the liquidity of other intangible assets this could be revised upward. Buybacks for a company with negative ABV are value-destructive since your share of negative equity increases - in fact, existing shareholders benefit from stock offerings in this case.
Free cash flow is "free" only to the extent that it can be deployed into assets that build ABV. If a company is generating excellent free cash flow but its ABV is declining, that tells you that either your measure of ABV is inaccurate or your measure of FCF is inaccurate. Of course, since ABV is a function of the investor, FCF is also a function of the investor.
My personal thesis has been that growth in liquid tangible book (i.e. excluding items like PP&E) is one of the best economic indicators of a business that is spitting out cash. Other businesses such as MCO, HCA, URI, AGN, and others may have excellent FCF but never seem to produce any surplus cash. Often it is found during periods of credit tightening that the intangibles (including their own stock) purchased by these companies weren't really as valuable as investors thought, with a consequent downward revision in both ABV and FCF. Taken together, these two adjustments can reduce a company's intrinsic value by a half-log or more. |
