Buyback Now, Payoff Later? : Critics Scoff, but Many Analysts Think There Can Be Big Gains in Tagging Along When a Firm Repurchases Its Stock
There is one investor in every public company that ought to have perfect knowledge of the firm’s real value and its ability to grow.
That investor does not work for the Psychic Friends Network or read growth lines in the chief executive’s palm.
No, that shareholder is the company itself--and an increasing number of market analysts believe that private investors who tag along with companies that are buying back their own stock can reap substantial gains.
Corporate stock buybacks, say proponents of the strategy, can be symptoms of greatness: They show that a company is healthy enough to fund its domestic and overseas expansion, pay for research and development and dividends and still have plenty of cash left over. They show that a company is investor-friendly enough to put that cash to work reducing the number of shares in the public market, making each one left more valuable. And they may show that the company, relying on insider knowledge, considers its shares undervalued.
Critics of the strategy don’t doubt the value of these portents. But they believe it is nearly impossible to determine whether a company has followed through on its announcement to buy back shares, and harder yet to figure out if buybacks truly affect the value of the remaining public stock. For example, buybacks have become popular as a kind of tax dodge, paying investors with a higher stock price instead of by dividends, which are taxed immediately as ordinary income. In addition, critics say, many firms repurchase their shares without making any announcement.
David R. Fried, a money manager in Malibu, believes that solid research on stock buybacks can tip the scales in private investors’ favor. And two years ago, he launched a monthly publication called the Buyback Letter ($149 a year,  289-2225) to help investors track the approach.
The letter lists all major buyback announcements each month (there were 140 in July), spotlights a few companies’ programs and follows a rather short portfolio of stocks. According to Fried, the buyback portfolio has been led this year by soaring shares of semiconductor maker Intel Corp., to a 24% gain through Nov. 9. The value of the S&P; 500 grew 18% in the same period.
Fried divides the buyback universe into three groups:
* Companies that never follow through on their announced repurchase plans and only use the declarations to signal Wall Street that they consider their shares undervalued. Ignore these whiners, he says.
* Companies that only repurchase stock when their shares are bargain-priced. An example, Fried says, is SkyWest, which regularly buys back its shares when they fall close to the airline company’s book value. These companies, he says, offer opportunities to profit over two to three years only if one can purchase shares near the price the company pays.
* Companies that are committed to long-term buyback programs to build shareholder value. This group, he says, is made up of companies such as Coca-Cola and General Electric and holds the most appeal for investors.
To illustrate the value of a buyback program, Fried says Coca-Cola repurchased 483 million of its shares from 1984 to 1995. As one result, he says, the company has turned 14% annual gains in earnings into 18% annual growth in earnings per share.
Critics of the approach, such as the Connecticut-based market research firm Birinyi Associates, mostly cast doubt on the reliability of public data on buybacks as well as on companies’ earnestness. According to a Birinyi white paper published in August, from 1985 to 1995, only 44% of the 1,155 companies that announced share repurchases completed them. During the same time, Birinyi reports, an additional 343 buybacks were not announced. Even of the successful repurchase programs, the firm concludes: “We are not persuaded that buybacks are indicative of future prices.”
Further muddying the picture are companies that issue new stock even as they’re repurchasing old shares. In 1993, according to Birinyi, Merck announced a $1-billion buyback, then followed up with a $2-billion buyback announcement in 1994. But corporate reports show an increase of 103 million Merck shares from 1993 to 1994, Birinyi says, largely because the company issued stock to purchase Medco Container.
How can a private investor profit on buybacks?
Fried advises that investors wait after an announcement to ensure that the company is truly buying back its stock. Evidence of a decreasing number of shares can be found in the quarterly reports that companies file with the Securities and Exchange Commission.
He advises that investors follow up with phone calls to the firm’s shareholder relations department to ask at least two key questions:
* Does the firm have a history of issuing new shares to raise money whenever its stock price rises? (That would dilute the advantages of its share repurchase program. Sell when the firm issues new shares.)
* Have buyback announcements truly reduced the number of a firm’s public shares? (Instead of retiring the shares, sometimes companies put them into either employee stock ownership or option programs, where they could eventually land back in the hands of the public.)
When Fried adds a stock to his buyback portfolio, he expects it to double within the coming two to four years. In addition to a legitimate stock repurchase program, he aims to find a profit, growth or transition story that has not yet been fully understood by the market.
Among the superstar companies besides Coca-Cola and GE that he believes “inexorably take shares off the market” are Wells Fargo and Philip Morris. Wells Fargo, he says, announced in April that it would repurchase 10% of its shares at a cost of up to $2.5 billion. As the firm has since proceeded to buy 3% to 4% of its shares from the public, the stock has risen from $250 to $278, though it dipped to $218 over the summer.
Another true believer in buybacks is the Shelby Cullom Davis & Co. investment firm in New York. The company manages more than $5 billion, including the wealth of the family of Shelby Cullom Davis--a gentleman who, according to lore, turned $100,000 into $1 billion over 47 years relying on share buybacks as an important part of his five-step value-oriented strategy.
Peter Russ, a securities analyst at the firm, said investors should beware of two dangers: companies that have jumped on the buyback bandwagon but don’t really generate enough free cash flow to fully finance the appetite for their stock, and companies that overpay for their stock.
Two examples of the latter, he said, are American Express and Morgan Stanley, which are in broad terms buying their stock at $10 to fund commitments to give executives options at $2. Morgan Stanley, Russ says, has diluted shareholder equity by almost $4 a share over the last six years in this way.
He snaps, “That is sheer value disruption.” To uncover such problems, Russ recommends that investors look at the cash flow statistics in companies’ annual reports, where firms must state the original price of each share they have repurchased.
Better companies like Wells Fargo with well-conceived buyback programs, he says, are using the tons of cash they throw off to accelerate earnings-per-share growth rather than to blindly diversify through unnecessary acquisitions. That makes his bosses very content billionaires.
“Wells Fargo is making my piece of the pie grow,” he says, “and I like that.”
Street Strategies explores tactics that the nation’s savviest private and institutional investors use to maximize gains and minimize risk. Jon D. Markman is a Times staff writer. He can be reached at firstname.lastname@example.org
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Shopping for Buybacks
David R. Fried recommends consideration of the following seven stocks whose companies are engaged in real efforts to repurchase their shares. Shares outstanding figures are approximate.
Friday price: $273.50
Shares outstanding: 93 million
Last buyback announced: April 1996 for $2.5 billion, or 10% of 100 million shares outstanding then
Why: California-based banking giant is using excess cash flow to buy back shares aggressively while expanding into other Western states
Friday price: $48.25
Shares outstanding: 697.8 million
Last buyback announced: January 1996 for $2 billion, or 6% of 700 million shares outstanding then
Why: Bad press about Arch Deluxe obscuring real story of explosive international growth; expected to accelerate buyback over next two years
Friday price: $101.125
Shares outstanding: 818 million
Last buyback announced: June 1996 for $2.1 billion, or 2.7% of 827 million shares outstanding then
Why: Tobacco and food giant buying back almost 3% of its shares annually; also has highest yield among 30 companies in Dow Jones industrial average
Friday price: $23.375
Shares outstanding: 149.7 million
Last buyback announced: December 1995 for $587 million, or 12% of 157 million shares outstanding then
Why: Stock of world-class franchise whose margins will improve dramatically in 1997 is priced near its multiyear low
Friday price: $47.375
Shares outstanding: 23 million
Last buyback announced: March 1996 for $102 million, or 8.7% of 25 million shares outstanding then
Why: Out-of-favor global producer of truck tires should roll as it completes transition to become a service company; announced very aggressive repurchase of 8.7% of shares in April
Federal Home Loan Mortgage Corp. (Freddie Mac)
Friday price: $109.25
Shares outstanding: 177 million
Last buyback announced: March 1996 for $1 billion, or 6.6% of 178 million shares outstanding then
Why: Continuation of strong share repurchase program likely because federal rules bar the government-sponsored firm from expanding into other businesses
Friday price: $14.375
Shares outstanding: 10 million
Last buyback announced: February 1996 for $6 million, or 4.6% of 10.3 million shares outstanding
Why: Selling just above book value, but earnings should be lifted by new fleet of fuel-efficient and low-maintenance planes; reduced shares more than 2.6% in last year