Buybacks Such as GE’s Signal Stock May Be Undervalued

General Electric Co.’s plan to buy up to $10 billion of its own stock over the next five years is perhaps the largest--but by no means the first--such program by a large company with a lot of cash on its hands and a feeling that its stock needs a little help.

“This has been an ongoing event in U.S. capital markets for several years,” said Norman Mains, director of research at Bateman Eichler, Hill Richards Inc. in Los Angeles. “This is not an isolated event, just a very, very large purchase by a major company.”

GE is embarking on the buyback program because its own stock presents the “best investment we can make,” Chairman John Welch said in a statement.

But what GE is really doing--as have companies such as Atlantic Richfield Co., IBM and Exxon Corp.--is sending a message to the markets that its stock is worth more than its current price, analysts said.

“When you have a stock like that, sometimes you have to grab it by the scruff of the neck and slap it in the face: Either raise the dividend dramatically, or buy back shares,” said John L. Manley Jr., a strategist with Smith Barney, Harris Upham & Co. in New York. “It says, ‘Look at me, I’m doing well.’ ”

The principle is simple: By repurchasing shares, the company effectively reduces the number of shares on the market. The fewer shares, the higher the value of each remaining share. A buyback also results in improved return-on-equity and return-on-investment ratios.

Recent large stock repurchase programs have included those of IBM, which has spent about $5 billion since May, 1986, to retire about 42 million shares. Last month, IBM’s board authorized the company to continue buying stock in blocks of 2,000 with total expenditures of another $1 billion.

Companies sometimes launch repurchase programs as a way to bolster share value as a defensive move against unwanted takeovers. More commonly, however, stock repurchase programs are one of many ways a cash-rich company like GE can invest its money to increase share values.

For some companies with little growth potential, a stock buyback offers a better way to bolster share value than capital investment, analysts said. An oil company faced with slack prices may choose to invest its cash in stock repurchases rather than new drilling because of the prospect of poor returns on future oil production, for example.

A stock repurchase has advantages over a strict dividend increase, which would provide shareholders with taxable income. In addition, “If you announce that you are going to buy back shares, you are not committed to buying them back every year,” Manley said. “But if you raise your dividend, you’re committed . . . until you cut it--and that’s the last thing you want to do.”

Repurchasing also allows a corporation to reduce its cash holdings and increase its financial leverage, or debt in relation to equity. Shareholders benefit from financial leverage to the extent that return on the borrowed money exceeds the interest costs and the market value of their shares rises.