03 October 2005

Do Buybacks Equal Greenbacks?

I was perusing the Times business headlines while taking a quick break from patent bar study. (Yes, posts should be fewer this week. If they aren't, I'm not studying enough.) A piece by Amy Feldman, excerpted below, caught my greedy eye. Its premise: that companies doing share repurchases, or buybacks, offer a higher return for investors than owning shares in companies that do not announce buybacks.

Sending Out a Message by Buying Back Shares

Companies have been repurchasing their own shares at record levels,
and the trend shows no sign of letting up. In the first half of this
year, share buybacks reached $163 billion, according to Standard &
Poor's, up 91 percent from the first six months of 2004. Howard
Silverblatt, an equity market analyst at S.& P., estimates that they
will surpass $300 billion for the year. That would be well above the
$197 billion for all of 2004.

Companies are splurging on their own shares for a simple reason: they
have a lot of cash and need to do something with it.
"Companies have more cash than they know what to do with," Mr.
Silverblatt said. "The number is just huge, especially in an
environment where it is cheap to get money. So companies have plenty
of money to do buybacks."

In general, buybacks are good for investors. After all, they represent a vote of confidence by management in the company's stock. And all things being equal, buybacks increase the earnings for each share by decreasing the number of shares held by investors.

Ok, so the Times is recognizing a huge trend among companies. Buybacks are the cool thing among CEO's and CFO's. But when something becomes cool, poseurs tend to follow along. So one should be on the lookout for which companies have the fundamentals to back up the stock repurchase versus the poseurs puffing up their chests and attempting to look strong.

David L. Ikenberry, a finance professor at the University of Illinois
at Urbana-Champaign who studies corporate buybacks, found that the stock price of companies that announced buybacks tended to outperform those that did not.

In an unpublished study of 7,725 announced corporate buybacks from 1980 to 2000, Mr. Ikenberry and three other researchers found that investors who held those stocks for four years earned a return that was 15.6 percentage points higher than that of a similar basket of stocks from companies that might or might not have announced repurchases. The results were consistent with a similar study
published in the Journal of Financial Economics in October 1995 by Mr. Ikenberry and two other academics that focused on stock buybacks from 1980 to 1990. The study is at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=686567.

A 15.6% difference over four years isn't an outsized megamillions-style gain. But there could be something to this. On a $50,000 portfolio, that comes out to a difference of $7,800. Nice.

Sorry for the interruption, let's continue with the Times. They don't really care for the rude interruptions.

"It is a phenomenon that is fairly robust," Mr. Ikenberry said.
"Companies buy back stock for all kinds of reasons. The biggest one is
a perception of mispricing. So these stock buybacks are considered
signals that management is confident of where the stock prices should be headed.
But not every buyback announcement is significant. Not all companies that say they will buy back shares actually do. And many buybacks - particularly among technology companies - are simply a way of offsetting the dilution that would otherwise accompany the exercise of stock options. "So many companies are doing buybacks, but they may not all be doing meaningful buybacks in the sense that they are big enough to give the company a reduced share count," said David R. Fried, president of Fried Asset Management in Pacific Palisades, Calif., and editor of the online newsletter buybackletter.com.

That said, more companies are doing meaningful buybacks these days and
some in huge quantity. Consider Exxon Mobil, the world's largest
energy company. As oil prices have soared, it has accumulated cash,
and it has been sharply increasing its share repurchases, up to $5
billion in the third quarter from $3.7 billion in the second quarter.
AND the buyback announcements keep coming, sometimes from companies
that have gone through tough times - like Time Warner and Motorola.
"They've had some problems recently, and they're trying to do some
signaling to the market," says Timothy Loughran, a finance professor
at the University of Notre Dame.

If you're interested in investing in companies that have had buybacks,
Mr. Fried recommends looking at valuations as well as the size of the
buyback programs. Among the stocks he likes are AutoZone, the auto
parts retailer, trading at 12 times earnings; Intuit, the maker of
Quicken software, trading at a multiple of 22; and Cigna, the insurer,
at a multiple of 8. "We look for situations where you've got the
buybacks and the valuations," he said.

I left out some of the boring parts for a change. But not too many.

I also remembered Cramer discussing this topic on his radio and CNBC show, back on September 23. Here's a recap:

Goldman Sachs "knows how to buy back stock," said Cramer. The company
bought back stock last quarter, and the stock is now trading 12%
higher than it was during the buyback, he said. Goldman just announced
another buyback this week, and Cramer expects similar results.

Lockheed Martin (LMT:NYSE - news - research - Cramer's Take), on the
other hand, also announced a buyback this week. But Cramer said
Lockheed's track record isn't so rosy. Last quarter, Lockheed bought
back stock, and the stock is now trading about 5% lower, he said.

The bottom line, said Cramer, is not all buybacks are created equal.
Goldman Sachs knows how to do a buyback. Lockheed Martin failed with
its last buyback and will "probably fail again," he said.

Cramer has a point that one needs to examine the company doing the buyback. I also think Cramer drank the Kool-Aid/read Dianetics/learned the secret handshake while at Goldman, meaning he's a sentimental booster of GS. Of course, the stock did jump recently.

I read on Marketwatch this morning that a company I ignored in my Discount Shopping Thesis posts, Dollar General (DG), announced a plan to repurchase up to 10 million shares over the next year. I checked the number of tradeable shares available in DG. Thestreet.com says there are approximately 321 million. This amounts to a buyback of 3% of outstanding shares.

The big question for me, as you may have seen in the title of this post: Do buybacks equal greenbacks?

How to separate out the good stocks from the wannabes?

Might as well throw out some usual numbers for the diverse array of stocks I culled from my reading:

Ticker/Share Price(as of 10/2/05)/PEG/ROIC/Enterprise Value/CNBC Stock Scouter Score
(Data is from smartmoney.com)

XOM - $63.54 - 1.89 - 27.74% - $59.82 - 9/10
AZO - $83.15 - .80 - 26.56% - $104.00 - 9/10
INTU - $44.81 - 1.32 - 21.53% - $42.27 - 6/10
CI - $117.86 - 1.37 - 24.84% - na - 9/10
TWX - $18.11 - 1.76 - 2.76% - $20.95 - 5/10
MOT - $22.03 - 1.66 - 18.02% - $22.03 - 10/10
DG - $18.34 - 1.06 - 17.88% - $18.40 - 6/10
GS - $121.58 - .87 - 4.01% - na - 9/10
LMT - $61.04 - 1.49 - 11.90% - $64.80 - 6/10

AZO has the best PEG, came in a sweet second on ROIC, and has an enterprise value about 25% higher than its share price. I don't need any more retail stocks on the WershovenistPig Stock Watch List, but this one's too good to ignore.

XOM has the nice ROIC, but I already have my eye on plenty of superior oil and gas stocks. I've got commodities covered.

DG has numbers comparable to FDO, currently residing on the Discount Shopping Thesis list. WMT is currently my pick among those choices, but between DG and FDO, I like the fact that DG is doing the buyback, however meager the 10 million shares authorization turns out to be.

TWX, so maligned (just check out Jeff Jarvis' Buzzmachine for embittered talk of TWX.) It will be interesting to see what TWX does with its AOL subsidiary. Otherwise, the PEG and ROIC are crap. And I'm not excited about media stocks. This stock could be the big poseur in this group.

INTU and CI have nice ROIC numbers. But INTU's enterprise value is below its share price. CI doesn't have an enterprise value, at least on smartmoney.com. Yahoo! Finance has CI's enterprise value below its market cap to the tune of $1B. And CI is at its 52-week high.

MOT and GS have had nice runs as of late. I think a little too rich for me right now, but these are leading companies that could pullback over the next few months. MOT certainly has come off its 52-week highs.

Here's my Buybacks = Greenbacks Basket for the WershovenistPig Stock Watch List:
AZO, INTU, CI, MOT, and GS. Talk about cohesion: an auto parts retailer, accounting software company, health care insurer, cell phone and telecommunications bigshot, and premier investment bank. It's an instantly diversified portfolio. Go me!

1 comment:

John Coumarianos said...

What if the company buys back its stock when it's too rich? The issue isn't whether Goldman buys back stock and the stock goes up over the next few months, it's whether Goldman's really buying the stock when it's undervalued, based on something longer term than the next quarter. Buybacks can destory capital as easily as anything if they're done when the stock is too rich. If I owned XOM, I'm not sure I'd be thrilled with them buying back stock at these prices. A dividend might be less destructive of shareholder capital if the stock is too rich.

Is it possible to get Cramer to think beyond the next quarter?