I am a keen observer of private equity, which I consider smart and patient money. I had made decent returns in the past by following them into particular sectors and industries that were out of favor with mainstream Wall Street. I recently noted that the multiple applied to many deals is getting very high. The average deal is being done with EV/Ebitda multiples above 11, which is the highest average I can recall. David Rubenstein of Carlisle Group (CG) described recent deal levels as ''a little frothy.''
Cash balance at leading private equity firms are piling up as they exit older deals, and firms are having a hard time finding attractively-priced targets, due to high valuations. This doesn't seem to bother executives at listed U.S. corporations. These folks are routinely spending shareholder money to buy back company stock in the market. High valuations based on enterprise multiples, earnings or asset value just do not seem to be a factor for these corporate managers. They simply cannot find anything else to do with all this cash.
This is a horrible use of shareholders' money. If you really cannot find anything else to do with the cash then send me a dividends check, before you buy back stock at higher enterprise multiples, and at several times book value. I am not a fan of buybacks done at these elevated valuations, and investors should avoid owning stocks of companies that engage in such buybacks.
Home Depot (HD) is one of the biggest violators. It isn't just using shareholder cash, but also borrowed $2 billion, to buy back its own shares. If this were being done at low valuations, perhaps I could make a case for it, but Home Depot shares trade with an Enterprise-to-Ebitda multiple of 11.8. The stock is trading at 10-times book value and 23-times earnings, so it is not exactly a bargain. Perhaps the company should have considered spending the cash on updated cyber security systems. I also find it interesting that many executives who voted on the buyback and the bind issue have been selling their own shares in the open market.
Calloway Golf (ELY) has just announced a $50 million share buyback. The golf business is horrible right now, and the stock is far from cheap. They should have increased the meagre dividend and let shareholders decide how to use the money. Calloway is an unprofitable company trading at 2.5-times tangible book value, and the EV/Ebitda ratio is in nosebleed territory at 17. I used to be a big fan of Calloway, but buybacks at extended valuation levels makes no sense to me, and I see no reason to consider owning this stock today.
Sherwin Williams (SHW) is another company that is using shareholder cash to pay for expensive stock. The shares currently trade at 30-times earnings and more than 13-times book value. The EV/Ebitda ratio is over 16, so I do not see any measurement that would suggest the shares are a bargain. Even if the company does benefit significantly from a stronger housing market next year, all the potential good news already seem to be reflected in the stock price. Either use the cash to expand the business, or send it back to shareholders. At this level, buying back shares is just a waste of shareholder cash.
Once, a private equity investor told me that he used an EV/Ebitda multiple of 5 as his maximum buying level. Tobias Carlisle has just wrote an excellent book titled Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, in which he makes a powerful case for buying shares at very low levels of EV/Ebitda. His research suggests that buying stock in the bottom 10% as raked by the measure is a very successful way to buy stocks. Today, that would be a multiple of 7 or less. It strikes me that corporate managers buying back shares at many times that level are not acting in the best interest of their shareholders.
I don't care to have my money invested in companies that waste my money buying expensive shares.