| Before buyback | |
|---|---|
| Share price | $42.77 |
| EPS | $2.81 |
| Earnings Yield | 6.57% |
| After tax cost of borrowing | 3.50% |
| Number of outstanding shares | 391,050,000 |
Figures for current stock buyback
The figures here are from Lorillard’s 2012 results and the borrowing figures are based on the company’s $500 million debt issuance at the end of last year, for which the company is paying on average 3.5%. However, Lorillard’s stock appears to be more expensive than that of Apple with an earnings yield of 6.57%, double the rate that the company is borrowing at, indicating that the company’s borrowings will benefit shareholders, albeit to a lesser extent than Apple Inc. (NASDAQ:AAPL)’s.
| After Buyback | |
|---|---|
| Earnings after borrowing cost | $1,081,440,972 |
| Shares outstanding | 379,420,000 |
| EPS | $2.85 |
Figures for current stock buyback
Assuming the company’s earnings remain constant, after deducting interest on the new debt, Lorillard’s earnings per share will grow 1.4% thanks to the buyback.
A debt binge
Lastly, let’s take a look at DIRECTV (NASDAQ:DTV), which has been borrowing heavily to finance buybacks during the past few years, but has it been worth it? The figures I use below are for the company’s 2011 buyback, which ended during 2012.
| Before buyback | |
|---|---|
| Share price | $46.25 |
| EPS | $2.48 |
| Earnings Yield | 5.36% |
| After tax cost of borrowing | 4.00% |
| Number of outstanding shares | 886,000,000 |
| Planned buybacks | 134,000,000 |
Figures for 2011 re-purchase operations
DIRECTV (NASDAQ:DTV)’s buyback program has been running for five years and has been funded entirely through huge amounts of borrowing, which has had a knock on effect on the company’s cost of borrowing. Indeed, both Lorillard and Apple have been able to borrow at rates almost half that of their earnings yield. DIRECTV (NASDAQ:DTV), in comparison, is borrowing at a rate of 4%, compared to its earnings yield of 5.63% for 2011. That said, DIRECTV (NASDAQ:DTV) is still borrowing at a lesser rate than its earnings yield, signifying that shareholders will benefit from the buyback.
| After Buyback | |
|---|---|
| Earnings after borrowing cost | $2,000,000,000 |
| Shares outstanding | 752,000,000 |
| EPS | $2.66 |
Figures for 2011 re-purchase operations
After the buyback, assuming earnings remained constant, DIRECTV (NASDAQ:DTV)’s EPS moved higher by 7.3%, an impressive rate of growth.
Conclusion
Earnings yield can be a useful way of finding out if a company is over/undervalued as compared to the market. It can also be a helpful way in calculating if a company is making the right decision in borrowing in order to return cash to shareholders All the companies discussed above have plenty of flexibility in their earnings yield, but DIRECTV (NASDAQ:DTV) could be running close to trouble if its borrowing costs rise higher.
The article Earnings Yield and Evaluating Stock Buybacks Funded With Debt originally appeared on Fool.com and is written by Rupert Hargreaves
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