The share buyback is back — good news for investors?
When companies buy back their shares, it’s a sign of confidence, says a U.S. advisory as it features a big firm that spends billions on buybacks.
There are two schools of thought on this.
When a company buys back its own shares, it automatically raises the earnings per share of the stock remaining in the hands of shareholders.
Thus those fewer shares are worth more.
There are those, however, who contend that share buybacks are not the best use of a company’s cash.
They don’t really increase earnings and they only benefit those who actually sell the shares. They also increase the value of any stock options the company’s officers may be holding, which makes some skeptical.
A leading U.S. advisory chooses to take the sunnier view of share buybacks. They represent a vote of confidence, says Dow Theory Forecasts.
And they are on the rise.
The advisory gives us the facts and figures on buybacks, and tells us why it views them as a sign of optimism for the markets.
It also features a famous firm that has made a point of buying back its own shares in large numbers, and raising its dividend into the bargain.
Record amount of cash
Before the two most recent quarters, share repurchases had fallen in six of seven quarters for companies on the S&P 500 Index.
But December quarter buybacks of $47.8 billion were up 37 per cent from the September quarter and 98 per cent from the June quarter.
Still, that’s not even close to the $141 billion spent on buybacks in the December quarter of 2007.
At the end of 2009, adds the advisory, non-financial companies on the S&P 500 held a record $381 billion in cash. They’re more conservative now than they were before the crash, but they certainly have the means to buy back shares aggressively.
Here’s one more number. In 2007 and 2008, spending on repurchases topped 75 per cent of operating earnings. In 2009, it was just 28 per cent. If the economy keeps on getting better, buybacks should keep going up.
Strong and confident
What’s so good about buybacks? This advisory likes three things.
“Historically, buybacks have been a signal that companies are both financially strong and confident about their futures.”
It also suggests that companies see their shares as attractively valued. The higher earnings per share produced by a buyback serve to reduce the price/earnings ratio and make the stock look more “undervalued.”
And of course, in reducing the share count, the company automatically drives up the per-share growth of profits and cash flows.
We turn now to a company that has profited through the recession and used a good deal of that money to buy back plenty of its own shares.
Leaner and meaner
In each of the last four years, IBM (NYSE-IBM) has seen its per-share profits rise by at least 12 per cent. This has been powered by “modest sales growth, a 16% decline in the share count and steady increase in profit margins,” says the advisory.
The “big blue” computer giant has spent years divesting itself of unprofitable assets, moving into new markets and generally becoming leaner and meaner.
It has certainly become leaner in the share department. Since 2005, IBM has spent $42.92 billion buying back its own shares. And it has not stopped there.
Not content to reward shareholders by reducing the number of shares, it has also spent $10.53 billion on dividends.
Share buybacks improve the value of a stock on paper. More dividends add up to real money in an investor’s pocket.
Meanwhile, IBM should gain $100 billion this year and is projected to maintain double-digit growth in per-share profits for the next few years.
Once a cyclical company that sold a lot of hardware when business was good, IBM now is a firm for all seasons as it depends more on software and services buttressed by a series of licensing agreements.
This advisory makes it a Focus Buy (best buy over the next 12 months) and a Long-Term Buy (best buy over the next 24 months).
IBM yields 1.7 per cent on its $2.20 dividend and trades today at $130.58.
The share buyback, of course, knows no borders. A number of Canadian firms have announced share buybacks this year. More will surely follow.
If this advisory is right in seeing this as a sign of confidence, then the more shares that vanish from the market, the merrier things will be.
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