Buybacks no clear buy signal

A growing number of companies sitting on piles of cash have found a way to invest it close to home: buying back their own shares.

By RUTH MANTELL, MARKETWATCH
October 1, 2006 07:45
4 minute read.

 
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MarketWatch: In-depth global business coverage A growing number of companies sitting on piles of cash have found a way to invest it close to home: buying back their own shares. But does a corporation's bullishness on its own stock create a buy signal for the average investor? "Companies feel that the values are so significant that this may be the best bang for their buck for the excess cash that they own," says Mark LoPresti, a senior quantitative analyst with Thomson Financial. Announced buybacks reached $69 billion in July, nearly quadrupling the level attained a decade earlier of $18b., according to Thomson. But that doesn't necessarily mean investors should follow suit. While a stock-buyback announcement can be a catalyst that pushes shares higher, whether or not those gains can be sustained long-term depends on other factors that investors must heed, fund managers and financial analysts say. Duncan Richardson, chief equity investment officer with Eaton Vance Management, says share buybacks are "certainly one factor that we look at, but no one management decision in isolation should be a buy signal. If a company is stepping up to buy their own stock, that is certainly a signal, but the real signal is the valuation," he says. "I think a more powerful signal is insider buying." Before placing any bets, investors should perform a bit of their own digging into a company's financial health, looking at its balance sheet, market reputation, prospects and past results, analysts say. And they need to be aware that just because a company says it is going to buy back its own stock that doesn't mean it has to carry through. Bob Costomiris, portfolio manager for the Wells Fargo Advantage Mid Cap Disciplined Fund, with over $800m. in assets, won't make an investment decision for the fund based solely on a buyback. But the announcement can add weight to the manager's decision to buy. "By definition, a buyback is going to truncate the downside; you have a party out there buying the stock," he says. "But you might have to be suspicious of buybacks for growth companies that are expensive, or for companies that have poor balance sheets.: Some warnings Investors should also be aware that companies sometimes initiate buybacks to offset dilution from stock-option grants. "Buybacks are positive for earnings if they reduce the share count, but they can be a false focus," Richardson of Eaton Vance says. "Investors should ask if buybacks are more than offsetting dilution from the issuance of options." Costomiris of Wells Fargo warns about companies that take on a lot of debt to finance buybacks, and companies that may be announcing one-time buybacks without the likelihood of other positive future events. "As an investor, you need to be worried about what happens a month or a year from now when the buyback is complete and the artificial prop under that stock is no longer there," he says. Still, for companies that grow slowly, trade cheaply and have strong balance sheets, Costomiris says buybacks are "an unequivocal positive." He points to Juniper Networks, one of dozens of firms that the market has punished for stock-option-related snafus, as a stock where a buyback announcement makes a difference. In Juniper's case, its shares had continued to fall after management announced in July a buyback for up to $1b. But the buyback announcement and the stock's weakness were factors that led Costomiris to increase the fund's position in Juniper to $15m. by the end of July. "With Juniper, the stock has gotten absolutely decimated and a lot of the short-term [concern] has to do with options," he says. "So, we look at the risk/reward to Juniper. We and our shareholders are likely to sleep a little easier with Juniper knowing that there's a buyback out there." While a buyback announcement may not necessarily send a strong buy signal, it can still constitute a thoughtful corporate move and encourage shareholder faith in management. "I view it as a wise allocation strategy for any company that's sitting on more cash than they need to return that cash to shareholders," says Walter Pritchard, a senior analyst with Cowen & Co. "It can be wise to buy their own stock, especially if it's undervalued." In July, Microsoft announced a share buyback for up to $20b. - the largest announced by any company this year - along with a $20b. tender offer. Pritchard sees Microsoft shares outperforming the market in the next 12 months, but not necessarily because of the buyback. Rather, he likes the prospect of a refreshed product line in the next few years. Study finds opportunities There is at least some academic evidence that stock buybacks do provide an opportunity for investors to make money. Theo Vermaelen and Urs Peyer, two professors at Insead, a graduate business school in France, tested returns for 11 portfolios, each comprising 50 companies with relatively significant undervaluation and which had announced a repurchase plan in the prior year. The study found that the portfolios, started each year from 1992 through 2002, did better than a market benchmark. Vermaelen thinks the market can overreact to bad news, providing fertile ground for management to buy back shares, lifting the stock's levels and rewarding investors with faith in the company's long-term prospects. MarketWatch: In-depth global business coverage

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