Firms splurge on own shares

Analysts question value of buybacks

August 22, 2006|By MCCLATCHY-TRIBUNE

DALLAS -- U.S. corporations are slurping up their own shares like it's feeding time on a pig farm.

Companies in the S&P 500 spent $349 billion repurchasing their shares last year, compared with $197 billion in 2004, and that figure is expected to move even higher this year.

Amid the stock market's meanderings, those buybacks have provided a source of optimism. Anytime big investors are buying - even if it's companies repurchasing their own shares - that's good news for the market.

But some analysts question whether buybacks are good for the companies that undertake them, particularly in the long run. For example, the companies may be tempted to use the shares for acquisitions, and companies that go on corporate shopping sprees often wind up with buyer's remorse.

What's not in dispute is that the volume of buybacks continues to set records.

"The number of buybacks is just going bananas," said Howard Silverblatt, senior analyst at Standard & Poor's. "It's been going on for seven consecutive quarters, and we don't see it slowing down."

Companies typically buy back shares only when they believe their stock is going up, said Jeff Ryan, senior research analyst at the Schwab Center for Investment Research in Chicago. Conversely, companies will issue more shares when they believe their stocks are overpriced, he said.

"When you see a significant buyback of 2 percent to 3 percent of the outstanding shares, that is a good indication that management believes the company is undervalued," Ryan said.

Another benefit for investors is that buybacks significantly affect companies' earnings. That's because, as the number of shares is reduced, the earnings per share ratio rises.

Among the S&P 500, "when companies say they had a 12 percent earnings per share gain, well, 4 percent of that came from the reduction in shares," Silverblatt said.

In the first quarter of 2006, 108 of the S&P 500 companies cut their share counts by 4 percent or more.

Through the first half of this year, stock repurchases totaled almost $200 billion, so topping $400 billion for the full year is very probable, Silverblatt said. On Friday, Microsoft Corp. said it was accelerating its continuing $40 billion buyback program.

A confluence of factors has contributed to the rise in stock repurchases. First, companies are flush with cash after 16 consecutive quarters of double-digit earnings growth.

"Over the past five years, cash holdings by S&P 500 companies have grown to a record size," Silverblatt said.

He estimates the cash buildup among S&P 500 industrials - which excludes financial firms and utilities - at $633 billion.

Second, corporate managers have been reluctant to spend much cash on acquisitions and new investments after the bear market of 2000-2002.

"Corporate executives are gun-shy and have been since the bear market," he said.

Third, the stock market - notwithstanding the recent rally - has not gained much in recent months, resulting in the perception, at least in the minds of executives, that their company stocks are bargains. Corporate managers need to do something with all the cash they are holding, so they buy their own beaten-down stocks.

Ryan of Schwab said buybacks are a good predictor of the movement of a company's stock price - better, even, than the buying patterns of corporate executives.

Many investors try to mirror the legal and highly regulated trades of corporate insiders, he said, on the belief that the executives know the company better than anyone else.

But Ryan said studies on the predictive value of insider trading are inconclusive. Corporate executives buy and sell their companies' stock for many reasons other than whether they think the stock will go up or down.

But when companies repurchase a significant number of shares - 3 percent or more - they are decidedly optimistic about the prospects of the stock, he said. And it's fairly simple for average investors to know which companies are buying back shares because the information is in the quarterly and annual reports filed with the Securities and Exchange Commission.

Ryan stressed, though, that investors shouldn't use just this one indicator to decide whether to buy a stock.

There are many other variables to consider, such as company fundamentals of revenue and net income growth, long-term debt, the general momentum of the market, valuations and risks. Schwab considers 18 factors before recommending a stock, he said, but a hefty buyback is among the most important ones.

Research on the correlation between buybacks and stock prices shows mixed results. Schwab found that in slightly more than half the cases it analyzed, the stock prices of the buyback companies were higher a year later.

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