Stock Buybacks: Good Buys, or Buyer Beware?

Rudy Martin

As an astute investor, your wish is for the value of the stocks you own to remain largely unchanged for the next half-decade, right?

No? Well, not unless you happen to be the undisputed champion investor of all time: Warren Buffett.

During the annual ritual that dominates investment news every spring — the Berkshire Hathaway (BRK.A) shareholders’ meeting — even the most insignificant utterance of Chairman and CEO Buffett is elaborated on at endless length by all the world’s investment pundits.

This year, prompted by a new IBM Corp. (IBM) stock-repurchase initiative, one of the Omaha Oracle’s past nuggets of wisdom was brought to light.

In a 2011 shareholder letter, he indicated that “we should wish for IBM’s stock price to languish throughout the five years” after a previous Big Blue stock-repurchase program.

That’s a pretty surprising statement for a man whose company owns about 70 million shares of IBM … or so it would seem.

After all, why would he want shares he owns to stagnate?

IFTHEN(FIELD9=1) {

Why Gold’s Run is Far from Over …

Anyone who thinks gold’s run is over simply isn’t paying attention.

In fact, just last week the Fed said: “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.”

This statement may seem neutral … but it is the first time the Fed admitted to the possibility of increasing its money-printing since “QE-Infinity” began.

It’s yet another reason why we believe it’s still a good idea to own gold … and that the long term outlook for gold is bullish.

The only question is, what’s the best investment strategy going forward?

Sean Brodrick gives you all the details here …

Internal Sponsorship

}

What Happens When Companies

Buy Back Their Own Shares

Companies, quite simply, like to be able to reward their shareholders. Paying a dividend is the most-popular way to keep investors, well, invested for the long haul.

Another way to say thank you to stock buyers is for the company itself to repurchase shares that are on the open market, which IBM recently said it would do again to the tune of $5 billion, in addition to raising its dividend.

It isn’t the only one.

Plus, as the financial press has been quick to report this past week, companies that repurchase their stock tend to be rewarded with higher prices over the longer term.

For example, Apple (AAPL) recently announced a record $60 billion stock buyback, on top of boosting its dividend. And last quarter, ExxonMobil (XOM) distributed $7.8 billion to shareholders in the form of dividends and share buybacks.

When companies invest in themselves that way, the shares and dividends can become even-more-valuable for their investors. With AAPL on the way to having its best month since August, it’s clear that buyers are lining up to take advantage of the potential rewards.

So, Why Would Buffett Want

IBM Shares to Stagnate?

In simplified terms, the seemingly convoluted logic behind the strategy of the earth’s third-wealthiest person is this …

If IBM’s price remains low during the stock-repurchase program, the amount of money set aside to repurchase shares will result in a large number of shares being taken off the market.

As a result, this raises the percentage of the firm owned by Berkshire Hathaway.

As Buffett once said, "We should wish for IBM’s stock price to languish."

Shares rose just 1.6% since it announced its newest buyback on April 30.

At an elevated IBM share price, fewer shares removed from investors’ hands would result in a lesser percentage gain for shares owned by Buffett’s firm.

This should provide a lesson that an announcement of a corporate share buyback is not necessarily a slam-dunk opportunity for automatic investment profits.

The Flipside of the Buyback Attraction

While some studies have determined that stock-repurchase programs tend to enhance subsequent investment returns, many buybacks have turned into disasters for investors.

As with everything in investing, careful analysis and good judgment are essential in evaluating the programs.

In other words, when you’re buying a stock, don’t base your decision on whether or not the company is in share-repurchase mode.

When it comes to Apple, for instance, I like that stock for a variety of reasons … and not one of them has to do with its planned $60 billion stock-repurchase program.

The most basic indicator of the probable success of a share buyback is simple logic …

If the stock is undervalued, then repurchasing its shares is likely to add value. But if it is overvalued to begin with, a buyback will only result in potentially more-pronounced overvaluation that will discourage investors from wanting the shares.

In Apple’s case, an anemic price-to-earnings ratio of slightly more than 10 — combined with a consensus estimate of a long-term annual earnings-per-share growth north of 20% — appear to be strong indicators of undervaluation.

Buyer Beware: Buybacks Can Help or Hurt a Stock

Apple’s buyback announcement did exactly what management hoped it would. It truncated a months-long slide and catapulted its stock price from the $400 level up to the $450-$460 range.

This happened despite a disappointing quarterly earnings announcement just prior to the share-repurchase announcement.

Apple shares are up 12.5% since

announcing its $60 billion share-buyback plan.

No question, Apple’s management orchestrated the buyback operation with the finesse and precision of a Navy Seal operation against an al-Qaeda target.

Not only did they couple it with a dividend hike, but they financed the share-acquisition program with a hugely successful bond offering — $17 billion at an average cost of only 1.8%.

If all that weren’t enough to ensure the effort’s success, Apple avoided a reported $9 billion tax hit by avoiding the repatriation of overseas funds in order to finance the operation.

Yet on the other end of the buyback spectrum, drug giant Merck’s (MRK) May Day announcement of a share-repurchase program so far has not paralleled Apple’s success.

Apple’s shares have risen 12.5% in the past two weeks, while Merck’s stock has appreciated only 10% year-to-date.

Priced at more than 23 times earnings, it would be a stretch to assess Merck’s shares as being underpriced. MRK went nowhere in the days following the buyback announcement, despite steady gains in the overall market.

As opposed to Merck, my Global Trend Trader model portfolio contains a pharma giant guided by some of the most-intelligent and hard-nosed business people on the planet. My stock-picking model likes the industry and that name in particular — it’s not looking at potential buybacks but rather solid buy-and-sell signals.

But if there is a fundamental development like a buyback or anything else that could help or hurt a position, my subscribers get my careful assessment of the potential underlying value and my detailed instructions on when and how to take advantage.

Join us today and find out which stocks are set to shine in the near term. Unlike the infinitely patient Buffett, you don’t have to wait up to five years to determine if a share repurchase, or any other fundamental development, is working out!

Best wishes,

Rudy

Your thoughts on “Stock Buybacks: Good Buys, or Buyer Beware?”

  1. Apple depends upon new and creative products to maintain growth. R&D cost money. Buy backs syphon cash from R&D.

Comments are closed.