Stock Buybacks
More Green Stuff e-Letter: Issue #7
December 12, 2006
Stock Buybacks: Using Insiders Buying As An Investment Indicator
by Alexander Green
Oxford Club Investment Director
At a recent investment conference in Charleston, I gave a talk on two of my favorite topics: insider buying and stock buybacks.
In my opinion, it’s tough to get a better leading indicator than when you see the top executives who run a company buying huge amounts of their own company’s stock, with their own money, at current market prices. That’s about as good a “heads up” as you’re ever likely to get.
“What about when companies buy back their own stock,” asked one attendee. “Isn’t that just as good?”
No. It isn’t.
Buying Back Stock Shares Is Generally Positive…
Don’t get me wrong. When a company is buying back stock shares, it’s generally positive. After all, it shows that management is confident the shares are undervalued. And a buyback can make a stock look attractive by giving an immediate boost to earnings per share, simply by spreading profits over fewer shares.
Stock buybacks have never been more popular than in 2006: Two-thirds of the companies in the S&P 500 bought back shares during the twelve months ended in September, retiring a record $430 billion in shares. That’s more than three times the total from just three years ago.
Microsoft, for instance, surprised investors this summer with a one-time buyback of $20 billion - and a promise of $20 billion more to come. Its stock, which had been residing in a small house with FIDO over the entrance, has since bounded 30% higher.
Exxon Mobil, too, has shown quite an appetite for its shares. The company has bought back stock for 25 consecutive quarters. And its shares have gained more than 60% (although rising oil prices didn’t hurt either).
General Electric and Citigroup have also been big buyers lately. They have been rising smartly as well, and currently trade near their 52-week highs.
However, a buyback announcement is a good place to start your investigation, not finish it.
Don’t Be Fooled by the Stock Buyback Announcement Itself
According to Birinyi Associates, a research firm in Westport, Ct., companies that had stock buybacks outperformed those that didn’t by a mere percentage point from 2000 to 2005.
That’s because buybacks often do nothing more than offset the share dilution that occurs when senior executives exercise their options - buying stock shares at a huge discount to the market, and then selling them immediately. (In the end, the number of shares remains unchanged.)
The New York Times recently reported that two professors at Georgetown found “in a study of more than 7,000 buyback announcements from 1981 to 1995 that the number of shares in the companies making the announcements actually increased by 24%, on average.” Believe me, it makes no difference how big a buyback is if there are more shares outstanding in the end.
To add insult to injury, companies are not even required to follow through on their stock buyback announcements.
- The financing or cash flow may not be available.
- Industry conditions may take a turn for the worse.
- Or management may simply change its mind.
Clearly, stock buyback announcements are no panacea. But they have their plusses… if you know what you’re looking for.
Your Best Bets for Buybacks Right Now
If a company’s shares are truly undervalued - and management is not merely offsetting the share retirement with their own option compensation - a buyback announcement can be a genuine catalyst for higher prices.
After all, the company is not only about to invest hundreds of millions or billions in its own stock, it is also ringing a bell to alert institutional investors that a bargain has developed.
My research shows that small to mid-cap companies with high price-to-book value ratios are generally the best investment candidates when a stock buyback announcement is made. One study found that the 50 stocks that met these conditions in every year from 1992 to 2002 produced gains 65% greater than the S&P 500 over the next four years.
So what interesting companies are buying back stock shares today? You might take a closer look at Big Lots (NYSE: BIG), TJX Companies (NYSE: TJX), Intuit (Nasdaq: INTU) and Amazon.com (Nasdaq: AMZN).
Best Regards,
Alexander Green
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More Green Stuff’s Cribsheet:
- The S&P 500 Index reported that its companies spent $116 billion on stock buybacks in the second quarter of 2006, up 43% from 2005 levels and 175% percent from 2004.
- Through the first nine months of 2006, S&P 500 corporations spent a record $325 billion on their own outstanding shares. Earnings for those companies during that same period were $590 billion, meaning these companies spent more than half their earnings power retiring shares.
- Reuters claimed that technology companies led third-quarter buybacks, accounting for 25%, while energy companies were responsible for 15% and financial-services companies for 12%.
- Stock repurchases are often used as a tax-efficient method to put cash into shareholders’ hands, rather than pay dividends.
Wit’s End
“I always keep a supply of stimulant handy in case I see a snake, which I also keep handy. ”
~ W.C. Fields
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- Insider Stock Information: How To Use It For Profit in Your Investment Portfolio
- Insider Buying of Stocks: The Strongest Purchasing Signal in the World?
