Buybacks picking up pace in '06

Critics suspect gaming, favor capital spending


Companies hunkered down after the corporate scandals, terrorist attacks and Internet bubble pop at the turn of the century and decided to focus on old-fashioned profitability. The strategy worked, and they amassed hundreds of billions of dollars of free cash, a record amount on corporate balance sheets. They could have used it for a mega-spending spree on new plant equipment, computers, office furniture, even real estate, but what did they buy instead?

Their own stock.

So-called "buybacks" skyrocketed in historical terms to $334 billion at Standard & Poor's 500 companies last year, pulling almost even with $342 billion that companies put to capital expenditures. While the capital spending roughly equaled 2001 levels, buybacks were more than double the average over the past five years.

Buybacks tend to juice a company's stock price and, in theory, earnings per share, which makes Wall Street and shareholders happy. Buybacks have become a rallying cry for hedge fund activists and corporate raiders such as Carl C. Icahn, who dropped a proxy fight at Time Warner Inc. last month after the world's biggest media company agreed to increase a buyback to $20 billion, among other concessions.

But buybacks can also be a tool for executives to manage earnings or stoke stock prices in the short run, and some economists warn that executives may be underinvesting in their businesses. A recent survey of money managers revealed that a majority believe companies should spend more on themselves.

"If you become too inwardly focused on simply building financial strength, you do so at the risk of falling behind in terms of competitiveness," said John Lonski, chief economist at Moody's Investors Service in New York. "Private equity firms and hedge funds just add to a sense of risk aversion on the part of corporations.

"They don't want to be seen as using company funds unwisely," Lonski said.

The buyback craze has continued at an even faster clip this year, as companies have unveiled plans for more than $90 billion worth of purchases, according to TrimTabs Investment Research. Merrill Lynch & Co. announced last week the financial firm's biggest-ever share repurchase of up to $6 billion. 3M Co., which makes everything from Scotch tape to touch screens, and Halliburton Co., the oil services company, also announced buybacks last month.

Among Maryland companies, Baltimore-based FTI Consulting Inc. upped its share-repurchase program last month to $50 million. Towson-based Black & Decker Corp. and Bethesda-based Coventry Health Care Inc. also expanded buyback plans recently.

Executives use buybacks to signal to the market that they think their company stock is cheap and should be fetching a higher price, and the strategy seems to work. Nearly 400 of the S&P 500 have announced buybacks since 2000, and those stocks are up more than 60 percent on average, compared with 20 percent for their peers, according to Birinyi Associates Inc., a stock market research firm in Westport, Conn.

That benefits everyone, said Charles Biderman, founder and chief executive officer of TrimTabs in Santa Rosa, Calif. When companies were net buyers of their stock during the past decade, the entire market has gone up, he said. Conversely, when companies have been net sellers, meaning they issued shares for options or sold them to raise capital, the market has been down.

The spate of buybacks also means that companies are gearing up for a round of mergers and acquisitions, according to Howard Silverblatt, an analyst at Standard & Poor's. "Companies have not retired many of those shares; they have moved them into their treasuries, and they can reissue them at will," he said.

However, investors should be keen to watch for when executives employ buybacks to massage earnings per share, a number that investors closely follow and that climbs when profit is being spread across fewer shares, said Sudhir Nanda, an analyst at T. Rowe Price Group Inc. in Baltimore.

Investors also need to be wary of buybacks done after companies have issued tons of options, so that the number of shares outstanding remains largely the same, he said. Options allow employees to buy company stock at a certain price in the future. "There is the headline news, and then there is what is actually going on under the hood," Nanda said.

The impact of buybacks on any one company is decidedly mixed and hard to separate from other factors, Birinyi Associates found. Home Depot Inc. has announced several of them totaling more than $10 billion since 2000 but its stock has lagged behind the S&P 500 index by nearly 30 percent. Autozone Inc., in contrast, has announced more than $5 billion worth, and shares of the auto parts seller have more than tripled as the S&P fell.

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