Buybacks aren't necessarily bullish

NEW YORK - The way companies like to spin stock buybacks, they make them seem like a no-lose situation for investors. But the truth is that share repurchases often do little or nothing to boost shareholder value.

Stock repurchases can boost earnings per share and lift a company's return on equity. And they can be seen a positive indicator of managers' view of a company's prospects. But are they necessarily bullish? Don't count on it.

Buybacks happen when a company goes into the open market to purchase its own stock, usually with cash. They've grown increasingly popular in recent years thanks to large cash holdings piling up on corporate balance sheets.

Companies in the Standard & Poor's 500 stock index spent a record $197.5 billion last year on share repurchases, up from $131 billion in 2003, and this year could easily top that given the pace of first-quarter buybacks, according to S&P.

Among the companies launching buybacks: Yahoo Inc., Home Depot Inc. and Merrill Lynch. International Business Machines Corp. announced in April that its board had approved the allocation of $5 billion to buy back shares, the largest repurchase in the technology company's history. And don't forget Microsoft Corp., which announced last summer its plans to buy up to a whopping $30 billion in stock in the coming years.

When announcing buybacks, corporate executives often tout them as a bargain for shareholders because they are scooping up shares they deem to be undervalued. And investors are supposed to think, "Who is in a better position to gauge a bargain than a company's management?"

Company leaders also note that buybacks leave fewer shares outstanding, which then should give each remaining share a greater percentage of corporate ownership.

But before investors allow themselves to get caught up in any kind of buyback marketing blitz, they may want to search for the real intention of a buyback. Morgan Stanley's chief U.S. equity strategist Henry McVey suggests investors should track a company's share count instead of looking at a company's cash flow.

While the top 25 S&P 500 companies spent $60 billion on share repurchases in 2004, the number of their outstanding shares only declined 0.27 percent. That's because stock grants to employees and stock issuance for mergers & acquisitions mostly offset the shares taken out of circulation.

Data culled by S&P's quantitative strategist Howard Silverblatt show that 39 percent of the S&P 500 companies that engaged in buybacks during the first quarter of this year reduced share count - which means 61 percent did not.

McVey notes that Dell Computer Corp. has spent $18.3 billion on buybacks since 1993 but has more shares outstanding today. "The way we see it, a lot of money is just being transferred to employees or acquired companies, not back to shareholders," he said in a recent report to clients.

He also worries that companies far too often buy stock that has already run up in value, with the timing of buyback activity often a "buy high, sell low phenomenon." He also points out that many companies announce, yet never actually complete, major repurchase plans.

McVey worries that when executives choose to do buybacks rather than investing in a company's future growth by putting money into its core businesses, they are "at least minimizing the upside return on their investment" or destroying value by "redeploying their excess cash flow to buy back expensive stock, especially when the bulk of it is linked to options issuance."

That issue could get even more pronounced this year as companies scramble to accelerate the vesting of their stock options ahead of possible changes in accounting regulation that would require them to deduct option costs from earnings, Silverblatt said.

The downside to buybacks also shows up in stock returns. The quantitative strategy team at Morgan Stanley looked at the effects of share buybacks on stock performance at large- and mid-cap companies over the last year, and the news isn't particularly good.

Large-cap portfolios built exclusively on a share-buyback theme would have lost 4 percent in the 12 months ending in April. A similar portfolio of mid-cap stocks would have generated returns of 4 percent, but that is lower than the 8 percent annualized returns since August 1992.

Don't count on any of this to stop corporate leaders from pushing the benefits of buybacks. It's just up to investors to understand how to cut through the hype.