There are a lot of things companies can do with their money. Give employees a raise? Sure. Invest in a new warehouse? Definitely. Issue dividends to shareholders? Encouraged.

But one of the more befuddling uses of corporate cash to outside observers is when companies go out into the open market, buy shares of their own stock, and then “retire” them.

The effect of this bizarre transaction? The company has reduced its cash on hand, draining financial resources from its balance sheet in exchange for reducing the number of its outstanding shares.

For anyone who continues to hold a stake in the business, this has the delightful consequence of increasing their ownership claim. Their percentage ownership over the business has grown as the share count has fallen, leaving shareholders to scream “Sublime!” in unison, akin to Ryan Gosling's utterance in 2023’s smash hit Barbie.

Owning more of a great business truly is, indeed, sublime.

Few companies have been as prolific cannibals of their own stock as AutoZone, a franchise that has, in two decades, spent tens of billions of dollars consuming 90% of its outstanding shares. Underpinning those buybacks is a hugely successful business, one that has consistently generated exceptional returns on capital.

Let’s go under the hood 🧰

— Shawn

AutoZone: How to Buyback 90% of Your Stock

Get in the zone, AutoZone. You’ve surely heard the jingle, and you probably routinely drive past AutoZone stores, at least for those based in the U.S.

With 6,400 domestic stores and 900 international locations across eastern Canada, Mexico, and Brazil, AutoZone has a massive footprint in the auto parts industry.

Consider, for a moment, the vast array of vehicles you see on the road, differing by make, model, and year. Each vehicle has its own subtleties and requirements, and each one is likely very important to its owner.

Your car is a way of life. It’s how most Americans commute to work, visit family, go on vacation, and travel to the grocery store. For others, like Uber drivers, it’s literally their place of work. And for landscapers, HVAC technicians, and other handymen of all stripes, their vehicle (usually a truck) is an equally important part of their workflow.

Vehicles are also not cheap, as anyone who went car shopping during the pandemic knows. As of November 2024, the average new car sold for a stunning price of $48,978. That’s roughly 60% of the median household’s pre-tax annual income in the U.S.

Who should we trust, then, with tending to these precious investments? In a large way, for decades, the answer to that question has often gone through AutoZone. Either DIY, with folks buying parts from AutoZone to make repairs themselves, or commercially, with mechanics buying parts from AutoZone to make repairs for others.

SKUs For Days

As mentioned, there are a ton of different vehicles on the road, but to each car owner, that vehicle is an essential part of their universe. Fittingly, it’s quite stressful to encounter car problems, and drivers universally want a custom-tailored solution as quickly as possible. But that isn’t simple to provide when the average car has over 30,000 components.

Who can we trust to have expertise on nearly every vehicle on the road while also carrying the necessary parts for such an expansive catalog of potential customers?

Again, the answer is often AutoZone or one of its industry peers, like O’Reilly’s, Advanced Auto Parts, or NAPA.

Your run-of-the-mill AutoZone can carry over 20,000 parts, while larger hub stores hold over 50,000 SKUs, and mega-hub locations can carry more than 100,000 different items in their inventory. That’s comparable to the number of types of products at a Walmart, except entirely focused on auto parts.

E-Commerce Resistant

Inventory turns over slowly in auto parts retail, but that breadth of inventory is the distinguishing factor that has made this business well insulated against disruptions from e-commerce competitors like Amazon.

You don’t realize you need new windshield wipers until it’s raining, but at that moment, you need to get them. Ordering wipers on Amazon that arrive in two days does nothing for you. More likely, you will pull into your local AutoZone (which are conveniently located within 10 miles of 90% of Americans) and get them installed today.

The same is true for mechanics. They might order some parts in advance to have on hand, but if they have a car hoisted up being serviced, they can’t afford to wait on critical parts. You can count on them getting the needed parts from the closest auto parts retailer, even if that means paying a premium.

Carrying a vast inventory of products is a core part of AutoZone’s business model, ensuring that, whoever you are and whatever you drive, if you stop into a store, they can promptly source your part. Not to say it’s always on hand, but it can usually be quickly imported from the nearest hub or mega hub.

AutoZone probably has what you need, when you need it — unmatchable convenience compared with Amazon, which has consumed so many other areas of retail but holds a much smaller penetration in the auto parts world.

As we’ve discussed, cars are important and costly necessities of modern life. For professionals and car enthusiasts, knowing which parts are needed and how to install them may be of little concern, but for the rest of us, tinkering under the hood is a foreign and worrisome endeavor.

Most vehicle owners want to be reassured by an expert about exactly which part they need and have direct help with installation or at least some guidance on DIY repairs. This is where auto parts retailers thrive.

Swing by a store, and they’ll check your battery for you. If there’s an issue, they’ll find the battery you need and install it for you. Perhaps they’ll simply share some passing wisdom about vehicle maintenance generally or tips & tricks related to your specific issue. That service component is immensely valuable when the alternative is self-diagnosis and self-service. Amazon cannot match that.

Parts Retailing is a Good Business

With a 53% gross profit margin, a 14% net profit margin, and a 10% free cash flow margin, AutoZone can sell its products at a substantial markup, and after subtracting out overhead costs, like keeping its stores staffed and training that staff, it still has a healthy profit.

But after 40 years of operation, AutoZone is mostly a mature business in the U.S., growing by around 200 stores per year, mostly in Brazil. While new stores can be compelling investments, costing around $2.5 million to roll out but generating an ROI of 15% in their first year and becoming more profitable over time, management has remained quite disciplined about capital allocation.

They have a playbook for the types of places they’ll put new stores in and strict standards for how those stores can be configured, with ample and easily accessible parking being a must.

That formula for success has enabled consistent growth. After AutoZone scaled across rural America, targeting small towns lacking sophisticated auto parts retailers, it moved into suburbs and cities and then turned internationally for further expansion, first in Mexico and now in Brazil. There’s marginal growth still to be had in the U.S., much growth left in Mexico, and other countries they could probably enter from scratch down the road like Colombia, Peru, and Argentina.

Along the way, the company has accrued enough profits it couldn’t deploy into maintaining existing stores or into growth that, in 1998, management launched what would become one of the most aggressive share repurchase programs in corporate history, still going to this day.

Since then, the company has spent more than $36 billion on buying its own shares, reducing its share count to the tune of almost 90%.

In trimming shares and organically growing earnings, AutoZone has accomplished the remarkable feat of growing earnings per share by 20% per year on average since 1991. And it’s not stopping, either. From 2023 to 2024, AutoZone bought back another 1 million+ shares while growing net income by 8.5% per year over the last decade.

More earnings, fewer shares = the twin engines of earnings per share growth (the driving factor behind stock returns.)

Compounding earnings per share works in both directions, which people often forget. You can compound by growing earnings, or you can compound the decline in your share count to also grow earnings per share. And that compounding bears huge results for investors. A 90% decrease in shares doesn’t correlate to a 90% increase in earnings per share. Instead, it’s a 10-times increase.

See for yourself: With $100 in earnings and 100 shares, earnings per share is $1. Cutting shares by 90% leaves 10 shares left. On the same $100 in earnings, earnings per share is now $10.

So, a ten-fold increase in earnings per share from buybacks paired with a 10-fold growth in net income is how you jointly get a 100x increase in earnings per share since 1998 for AutoZone — the recipe for a 100-bagger investment, where $1 initially invested turns into $100.

Valuing The Business

AutoZone is investing around $1 billion a year in capital expenditures that maintain its current operations, such as renovating existing stores, and also for growth from building new stores.

With the remainder of its operating cash flow, as well as using cash raised by modestly issuing long-term debt, AutoZone has bought back $3-4 billion+ of its own stock annually since 2020, reducing its share count by an average rate of nearly 8% per year(!) and by 6% per year since 2015.

Again, earnings per share are what drives stock returns, and reducing shares outstanding is an equally valid way to boost earnings per share, aka EPS. With shares declining by 8% each year, earnings per share are correspondingly growing by 8% per year, so just with buybacks, holding everything else constant, investors receive a very satisfactory 8% rate of return.

Yet that assumes no growth in nominal earnings. With no real growth in earnings, just matching the inflation rate of 2%, investors would already receive a double-digit return (2% earnings growth + 8% reduction in shares = 10% increase in EPS.)

Assuming AutoZone can continue to grow its net income from expanding in the U.S., Mexico, and Brazil, or from finding operational cost efficiencies or selling higher-margin items, whatever it is, any inflation-adjusted growth in the business on such a large base of stock buybacks quickly adds up to a very attractive expected rate of return going forward.

For example, AutoZone has grown its net income, which I use interchangeably with the term “earnings,” by 9% per year over the last decade. If AutoZone can continue growing at a similar rate while still buying back 7-8% of its stock, your expected annual return is easily north of 15% per year.

A few problems: As EVs and hybrids become more common, this could reduce demand for auto parts — EVs have about half as many parts as traditional cars. With that transition structurally underway, assuming 8%+ organic growth feels aggressive.

Also, the current rate of buybacks may have to come down. A dollar spent on buying back stock is a dollar not reinvested into growing the business (i.e., new stores in Brazil.) So, it’s hard to sustain high rates of growth AND large buybacks, especially if the buybacks are being partially funded by debt (which they have been).

Going forward, to ensure I’m thinking conservatively about a potential investment in AutoZone, I’ll use lower percentage growth and buyback rates.

There’s one more problem to consider, too. AutoZone’s price-to-earnings ratio is near a decade-high, suggesting that the outlook for the stock is strongly positive, but any road bumps could pull the stock down sharply, bringing its P/E in line with more normal levels (between 16 and 18.)

As the business continues to mature, I’d typically expect its P/E to trend down on average anyway, so this is a real headwind to future returns.

For example, over the next 5 years, if earnings per share grow by 15% per year (8% from buybacks and 7% from earnings growth), you’d expect the stock to generate a 15% annual return as well. However, if AutoZone’s P/E were to revert to more normal levels, falling from around 20 to 16, the returns realized by an investor who purchases shares today would fall from 15% to 11%.

The point being: AutoZone’s commitment to buybacks can be a wonderful thing for returns, especially when combined with growth in the underlying business, but that can be significantly offset by a contraction in the stock’s price-to-earnings ratio should sentiment around the company sour.

Assuming more modest growth and buybacks, along with some compression in the P/E down to 18, I get an expected return of approximately 9% per year going forward — nothing special.

Portfolio Decision

With a recent range between $3,200-3,400 per share, I think the scope of outcomes skews in favor of average returns going forward, as I just showed. I like to think through what would happen most of the time if I could simulate a thousand different realities with different growth rates, buyback rates, and P/Es by 2030. And as mentioned, my feeling is that, at current prices, due to the elevated P/E ratio, this range of possible outcomes tilts toward mediocre results.

Yet, I think AutoZone would be quite attractive at a lower price, building in more of a “margin of safety,” as the father of value investing, Ben Graham, would say. If and when AutoZone’s stock trades 15-20% lower (approximately $2,800 per share), I’d be keen to begin building a small starter position in the company that I scale up over time.

If you want to play around with my basic model and see the range of returns you’d get with different variable inputs or from purchasing at a lower stock price, you can download my model for AutoZone here.

To hear the rest of the story of AutoZone, learn more about its growth prospects and competitive advantages, and how it stacks up against other auto parts retailers, listen to my full podcast on the company, which will help you decide on what types of numbers are realistic when adjusting the inputs in the financial model.

As always, I hope this is the starting point for your own research. Please let me know what you think of my conclusions in the poll at the bottom of this newsletter — I’ll be back again next week with another prospective company for The Intrinsic Value Portfolio.

Weekly Update: The Intrinsic Value Portfolio

Notes

• For the time being, I’m showing the portfolio holdings at cost for simplicity, though Alphabet and Ulta have both declined modestly since adding to the portfolio, so their real weights are slightly lower than shown
  

  • Eventually, I’ll adjust to show the weightings based on current market values rather than the weightings at cost
    

• I increased my stakes again in both Ulta and Alphabet by 1% as the shares continued to show weakness, bringing my average cost in Alphabet to $187.49 and $397.14 in Ulta.
  

  • Ulta has been brought down by the beauty brand ELF’s weak guidance for 2025, while Alphabet was brought down by concerns over DeepSeek and commitments to large capex spending related to AI
    

• My max position size is 10%, so I have some room to raise Ulta’s position size if the stock is really weak, but I will likely refrain from making meaningful additions otherwise

Quote of the Day

"In investing, what is comfortable is rarely profitable."

— Bernard Arnott

What Else I’m Into

📺 WATCH: How to fix the CEO succession problem

🎧 LISTEN: The secret to Buffett’s business success

📖 READ: Dan Rasmussen on AI and the Mag 7

Your Thoughts

Here’s what readers had to say about last week’s decision on Vital Farms:

• “Don’t like the issuing of stock/diluting the value.”
  

• “Love the eggs! I use them myself, had no idea it was a publicly-traded company. But I’m not sure I could see myself investing in an egg business long-term.”

See you next time!

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