Value of Buybacks Up in the Air Again
After IBM Corp. stunned Wall Street with an unexpected first-quarter earnings shortfall on April 14, Wall Street stunned the company right back -- by lopping 14% off its stock price over four days.
On Tuesday, IBM tried a different kind of shock treatment on the investment community: It announced its biggest-ever stock buyback program. IBM said its board approved using $5 billion to buy back shares on the open market or in private transactions over time.
Assuming the idea was to boost the stock price, the record-buyback news may have worked. IBM shares ended the week at $76.38, up nearly 3% for the five days, about 10 times better than the average blue-chip stock performed in the period.
Over the last 20 years or so, stock buyback announcements have been a favorite tool when corporate managers have felt the need to show they’re looking out for shareholders’ interests. The message they hope to send is, “We’re buying the stock to help support the price. And if we’re buying the shares, they must be cheap; otherwise, we wouldn’t waste your cash.”
But experienced investors know that sometimes there is less to buyback programs than meets the eye. The strategy has been uncharitably lumped in with other forms of financial engineering, a term used to describe management efforts to convince shareholders of value, or progress, that may not really be there.
Some money managers see buybacks as a negative, rather than positive, signal about a company’s fundamental prospects.
David Dreman, a veteran investor who heads Dreman Value Management in Jersey City, N.J., says buybacks are “almost a white flag” from corporate officers, an admission that they can’t find anything better to do with shareholders’ capital. Why invest in a business like that, he wonders? What’s the long-term growth story?
The debate over the wisdom of stock buybacks has heated up again because companies have been announcing such repurchases at a record pace.
The dollar value of announced buybacks reached $227.8 billion last year, eclipsing the previous peak of $224 billion in 1998, according to data tracker Thomson Financial. So far this year U.S. companies have announced buybacks valued at $86 billion, an annualized pace of $258 billion.
When they work as advertised, buybacks take stock out of the market. The net result is that a company’s shareholders own bigger pieces of the pie. Net income is spread over a smaller share base, so per-share profit can be higher than it otherwise would have been.
And simply by being in the market as a buyer, a company may help to push up its stock or lessen any downward pressure on the price.
What companies often don’t say when they trumpet buyback plans is that they’re buying at least in part to offset the issuance of new shares via employee stock option grants. In other words, the number of outstanding shares at many companies would be expanding, diluting investors’ interest, if management wasn’t simultaneously buying stock as employees exercised options.
A report by data firm Standard & Poor’s found that, in 2004, the majority of announced buybacks by S&P; 500-index companies were made to cover options issuance.
Still, some companies, including IBM, have in fact reduced their total share counts in recent years. And a number of academic studies say buybacks are a good leading indicator of above-average stock performance.
David Fried, a Pacific Palisades-based money manager who operates the buybackletter .com website, claims investment success by focusing on companies that follow through on significant buyback announcements. “We only invest in the ones that have shown share declines,” Fried said.
He says a buyback program is a way to return capital to shareholders and also may keep management from making ill-advised acquisitions or other foolish moves with accumulated profit.
But one of the obvious risks with buyback programs is that investors must trust company managers to buy shares when the price is a relative bargain, as opposed to when the stock is overvalued.
That is always a judgment call, of course. It’s a judgment investors like Dreman would prefer not to leave to management.
If a company has more cash than it can profitably invest, instead of a stock buyback pledge that may or may not be fulfilled, “I would rather see a higher dividend,” Dreman said.
With the federal tax cut on dividend income in 2003, cash payouts have far more value to shareholders than they did before. Many companies have responded by raising their dividends over the last two years, but the payout increases conceivably could have been far greater if managers weren’t also expanding buyback programs.
Sam Stovall, chief investment strategist at Standard & Poor’s in New York, said stock buybacks can serve a useful purpose. But as corporate earnings growth slows this year from the torrid pace of 2003 and 2004, he said, there is a risk that more companies could turn to buyback programs to try to create the illusion of faster growth.
When a company earns, say, $50 million, it’s still $50 million regardless of the number of shares it is spread across. A buyback could mask that a company is shrinking even though per-share results are rising, Stovall said.
“It’s like smoke and mirrors,” he said.
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Tom Petruno can be reached a tom.petruno@latimes.com.
