Investors have a few ways to get their money back once they invest in a stock. The most common way to collect returns is simply to sell a stock – hopefully – at a higher price. The second way is to collect dividends. Dividend stocks are the bread and butter of some retail investors; however, they aren't all sunshine and rainbows.
Dividends are paid out of a company's free cash flow (operating cash flow minus capital expenditures) unless the company takes on debt to pay dividends, which should be a red flag. Because free cash flow is taxable, investors receive dividend payments with taxed money, only to be taxed again as ordinary income on the dividend they received.
Double taxation sounds awful, and it is. This is why buying back stock is a much better—and efficient—way for management to reward shareholders. Stocks like FedEx Co. (NYSE: FDX), Ulta Beauty Inc. (NASDAQ: ULTA), and even Ross Stores Inc. (NASDAQ: ROST) are aggressively buying back their own stock.
Outside the merits of the individual companies, here is why stock buybacks can be the best way for investors to see their returns.
It's Basically Free Money
Companies issue a limited amount of shares to the market, meaning the pie size is set for shareholders to take a slice of what's available. If an investor owns 5 shares out of a total of 20 shares available, they own 25% of the company. Now, when management decides to buy back 5 shares, that investor owns 33% of the company (5 shares out of 15 total).
Stock buybacks enable investors to own a more significant piece of the pie. Ideally, the company is sound and expanding its profits so that the pie will grow larger. A vicious upside cycle is now created. The best part is that this money is only taxed once at the free cash flow level. Hence, the reward for the investor comes from more valuable equity holdings.
FedEx Buybacks Aren't Just Convenience
After announcing a 15% jump in earnings per share (EPS) over the past 12 months, FedEx reported $1.6 billion of free cash flow in its latest quarterly financial release. Knowing what could happen to the stock, management decided to bump its buyback program for 2024 up to $2.5 billion.
As a $71 billion company, these buybacks represent 3.5% of the business's size. Trading at a price-to-earnings (P/E) ratio of 16.4x puts FedEx at an 8% discount to its closest competitor, United Parcel Service Inc. (NYSE: UPS). While this may seem like an initial reason to buy cheap stock, logic doesn't stop there.
According to the latest employment situation report, the couriers and messengers industry added 17,300 jobs in February. This represents roughly 6.2% of the total 275,000 jobs added to the U.S. economy. A hiring spree can only mean more business ahead.
Knowing this, analysts Bank of America Co. (NYSE: BAC) felt comfortable boosting their price targets for FedEx stock up to $346 a share. To prove them right, the stock must rally by 19% from where it trades today. Price action favors this logic, as the stock wants to break its 52-week high again.
Ulta Stock: A Play for the Ages
Ulta Beauty has created a moat around its business model as part of the consumer staples sector. Whether the economy is booming or busting, consumers will keep tending to their skincare and beauty needs, making Ulta immune to the cycle.
More than that, the brand's value proposition and penetration are so efficient that more than 90% of customers become—and remain—members of the brand's network.
No other retail stock has reported such high adoption rates, which is why its return on invested capital (ROIC) rates are so high, a five-year average of over 25% per Ulta's financials.
As of March 2024, Ulta management decided to bump its buyback program to $2 billion, which would repurchase as many as 7.3% of all outstanding shares. Raymond James (NYSE: RJF) analysts think the stock could reach $630, a level that is 21% higher than today's price.
A moat around its product and high profitability rates make Ulta a stock that investors may consider holding for the long run. As management buys back more of its stock, that repurchase investment is now working at 25% rates of return, compounding the value of the stock faster for those looking to grow their wealth.
Another Cycle Play in Ross Stock
Markets potentially priced in the Federal Reserve's interest rate cuts for this year. Lower interest rate expectations and the highest consumer sentiment since 2021 can make Ross a crucial play for consumer discretionary names.
Now that the writing is on the wall, analysts at The Goldman Sachs Group Inc. (NYSE: GS) boosted their targets to $163 a share, daring the stock to rally by 12%.
Insiders may see this as a potential outcome because they announced a $2.1 billion buyback program that could buy back as many as 4.3% of the total shares out in the market.
Ross outperformed the Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY) by 16% over the past 12 months, and the stock keeps flirting with new all-time highs in a demonstration of momentum behind this strength.
