Perhaps equally noteworthy is the idea that just because the company does not become more profitable, this does simultaneously indicate that a shareholder’s ownership claim cannot be increasing. Over the last decade Kohl’s has significantly reduced its share count – from around 345 million in 2005 down to under 200 million last year. As such, negative company-wide earnings growth turned into 5% annual earnings-per-share growth.
The roller coaster ride continued as we move down the components, as the valuation that investors were willing to pay went from around 20 times earnings down to 12. While earnings-per-share increased by roughly 65% over the last ten years, the share price did basically nothing. Which, incidentally is the reason that shares look more attractive today – you have the same price, but a much lower share count and thus higher earnings claim.
Finally, Kohl’s initiated a dividend in 2011 and has been increasing this payout nicely in the year’s since. All told investors would have only seen total gains of about 1% per annum – certainly nothing to text home about.
When I review the history of Kohl’s I’m reminded of a few things. First, just because the business isn’t earning more this does not mean that a shareholder’s earnings claim cannot be improving. As seen above, the significant reduction in share count has allowed earnings-per-share to grow steadily.
Next, it places a vital importance on the valuation paid. It shows you the finicky nature of stock prices. A share of Kohl’s today has a 65% higher underlying earnings claim and yet it trades at the same price as it did a decade ago. That’s why it’s important to demand a reasonable (or better) valuation.
Finally, I’m reminded that past history does not dictate the future. It can give you clues, and certainly there is a “carry through effect,” but poor performance in the past does not necessitate that a security will always do poorly. Indeed, given a lower valuation and higher dividend yield, it could very well indicate the opposite.
So let’s move on to thinking about the future, using the above information as a teaching lesson rather than an absolute.
Future Growth
For 2016 the company has told you to expect earnings in the $4.05 to $4.25 range, which presumes roughly $600 million used to repurchase shares at an average price of $50. That means that Kohl’s is anticipating the share count to be reduced from ~195 million down to ~183 million for the year. It also implies that future earnings could be in the $740 million to $780 million.
Analysts are presently expecting intermediate-term growth to be in the 6% to 9% range. I’m going to scale that back quite a bit, call it 2% business growth over the next decade. If you’re using a $760 million starting point, that equates to a future earnings value of about $900 million after a decade. As a point of reference, Kohl’s has earned over $1 billion many times in its history – so this assumption isn’t exactly shooting for the moon. We’ll leave it there for the moment to move on to the next aspect.
The Dividend
Kohl’s started out paying a $0.25 quarterly dividend in 2011. The current mark is now double that, sitting at $0.50 per quarter. That leads to an annual commitment of just under $400 million. While it’s conceivable that the payout could continue to grow at a quick rate, the idea here is to keep things conservative as a means to reflect the uncertainty and inherent quality (or questions) about the business.
If the per share dividend payment were to grow by say 5% per year, you’d anticipate Kohl’s to pay a $3.25 dividend or thereabouts after 10 years. In total you might anticipate collecting $27 of so in per share dividend payments. Growing the dividend faster than company-wide earnings may give you pause, but it’s important to remember that we haven’t yet talked about share repurchases.
Share repurchases
As we saw above, Kohl’s had an exceptional share repurchase program over the past decade – decreasing the share count from about 325 million to below 200 million, or a compound decrease of over 5% per annum. This program was effective for three basic reasons.
Capacity: for the first half of that period no dividends were being paid, leaving more room for buybacks.
Willingness: Kohl’s has been putting very large amounts of capital towards this effort, sometimes upwards of a billion dollars a year.
Valuation: A good chuck of those share repurchases were accomplished when shares were trading with P/E ratios in the mid-to-low teens. When buying out past partners it’s much better to do so at a discount rather than a premium.
These three factors allowed Kohl’s to materially reduce the number of common shares outstanding. For every five shareholders that existed in 2005, just three remain today; Kohl’s bought out two out of every five shareholders during the last decade on your behalf.
Moving forward you may not anticipate that the share repurchase program can be quite as effective. For one thing, the dividend component now takes up a decent chunk of “organic” funds. Moreover, we’ve already presumed that the profitability of the company will be subdued.
Yet the other two factors remain. You still have the willingness to use funds toward this endeavor and the lower valuation makes buying out partners more effective.
