NEW YORK -- Investors often cheer when a company announces plans to buy back shares.
Here's some advice: Hold the applause.
Many buybacks don't do what they're assumed to do -- cut the number of shares outstanding -- says a recent report by Salomon Brothers Inc. If the repurchased stock goes into employee stock-option plans, it can end up back in the market when employees exercise their options, the report said.
"What they're doing is pulling it out of the market with the left hand and giving it to the executives with the right hand," said David Ikenberry, a finance professor at Rice University who tracks buybacks.
Buybacks are liked by many investors because they cut the number of shares outstanding, which can help boost per-share earnings and stock prices. Per-share profit is simply net income divided by the number of shares outstanding: The fewer the shares, the larger the per-share earnings.
"The market right now is enamored with stock buybacks," said Steve Zenker, a portfolio manager with McCabe Capital Managers in King of Prussia, Pa. "It's an easy way for [companies] to say, 'Hey, look, we're trying to help shareholder value.' "
Stock repurchases are hitting new highs. Buyback announcements worldwide rose to 1,840 last year from 899 in 1987, according to Securities Data Co. This year, buybacks are on track to pass last year, with 959 buybacks announced so far.
Buybacks tend to boost stock prices. Last year, the shares of most Standard & Poor's 500 companies did better than the market as a whole on the day they announced buybacks, according to the Salomon Brothers report.
The report, "Share Repurchases: Less Than Meets the Eye,` is based on data from past Salomon reports, company annual reports, Securities Data Corp., the Federal Reserve, Standard & Poor's 500 reports and various media reports.
As companies buy back more and more shares, they're also issuing more and more options. Salomon said 70 percent to 80 percent of stock issuance can be traced to options-related programs of companies in the S&P 500 Index, excluding banks and most insurers.
Options often are used by companies because they have advantages over cash: Options are tax-deductible, and their cost doesn't have to be included in reported earnings. Options give employees the right to buy a company's shares at a set price during a certain time period.
Options do have drawbacks, though. Give out enough options, and sooner or later stockholders will see the value of their investment diluted by the rise in the number of shares outstanding. To head off dilution, many companies turn to buybacks.
Health-care product maker Mallinckrodt Inc., for one, budgets about $50 million a year for repurchases to cover options.
"It's to protect our earnings base," said Scott Johnsen, a Mallinckrodt treasury analyst.
Many companies are fairly open about buying shares back to cover options, said Richard Slinn, a portfolio manager at Van Kasper Advisers in San Francisco.
"I happen to like employee ownership," Slinn said. He said he believes options help executives focus on improving performance and stock price.
"If you begin to extend ownership through the ranks, it does a lot to reinvigorate corporate culture," he said.
And knowing that a company is buying back shares simply to cover options is no cause for undue concern, said Michael Weisbach, professor of finance at the University of Arizona. "They would still have to give the managers shares," he said.
Other investors take a different view. A buyback that's designed to cover an option plan doesn't excite Scott Vergin, a money manager for the Lutheran Brotherhood in Minneapolis.
"If it's just to do that, it's sort of a wash," he said. "It's not nearly as positive as if they're going to retire the shares."
Pub Date: 7/20/97
