Stock Buybacks On Record Pace, A Bullish Indicator For Investors

By Craig Shaw
INVESTOR’S BUSINESS DAILY

It's good news when mutual funds snap up a public company's stock. But it's just as encouraging when a firm invests in itself.

From that perspective, 2004 has been a bonanza. Stock buybacks are running at the highest level in at least 17 years. Companies flush with cash are spending some of that surplus to boost the value of their shares.

"Corporate cash flow has been strong, the economy has been strong, and cash is building on balance sheets," said Charles Biderman, president of TrimTabs Investment Research. "It looks like companies aren't hiring but are using contract employees. So they're using their excess cash flow to buy back shares."

Corporate buybacks enhance a stock's value by spreading the firm's earnings over fewer shares. It's one way companies can spend down extra cash on their balance sheets, along with acquisitions, dividends and debt payments.

Buybacks this year hit $227 billion by the end of October. That's the fastest pace since TrimTabs began tracking the data in 1987. The next strongest year, 2001, saw just $192 billion in buybacks by that time.

July was one of the heaviest buyback months ever, thanks to Microsoft. The software giant said it would purchase up to $30 billion in stock over the next four years to help spend down its $60 billion cash hoard. It also announced a special dividend of $3 a share.

Buybacks slowed in August and September, but rebounded in October with the third-highest month on record. The last nine trading days of the month saw an average of five buybacks a day, Biderman said. Pfizer, Viacom and IBM were among the heavyweights announcing repurchase plans.

Just this week, Cisco announced a $10 billion buyback while Intel said it will buy 500 million shares, or about $1.15 billion.

Buybacks are a strong sign of corporate financial health because they show a firm has enough money to both cover expenses and make investments, said David Fried, editor of The Buyback Letter and president of Fried Asset Management. From an investor's perspective, it boosts the value of every share and suggests executives expect the stock price to improve.

"You own a bigger share of the company's profits without having to spend more money," Fried said.

Buybacks aren't always a sign of strength. Companies releasing bad news often will also announce buyback plans to signal management's continued optimism, warranted or not.

But buybacks typically are bullish. And it's not just market giants that benefit.

Diversified operations firm Raven Industries, a small cap, has bought back 11.8 million shares of its stock over the past seven years. It now has 18 million shares outstanding.

"It was a way to help leverage our balance sheet," said Raven Chief Financial Officer Thomas Iacarella. "We had a strong cash position, and once we ran out of debt to pay down, we started going after equity. Most people will tell you equity is the most expensive form of financing."

Raven raised the cash by selling off low-margin operations and pruning its 10 businesses to four growth areas. It made some acquisitions as well, and issued a special dividend of $1.25 a share, or $11.3 million.

"Our first priority (with cash) is to fund organic growth," Iacarella said. "Our second is to make strategic acquisitions. Our third is to repurchase shares."

Buybacks are a more tax-efficient way to return cash to shareholders than special dividends, Iacarella said. Even after recent tax cuts, dividends are still taxed at 15%. Buybacks create no immediate tax obligation for investors.

"I look at stock buybacks by a company as a very, very good thing," said Dick Gould, portfolio manager with Gould Investment Partners. "What it means to me is there's no better use out there to increase earnings per share other than buying back stock, which means they must think it's a pretty good value."

Wolverine World Wide said earlier this month that it would buy back 2 million shares of stock over a two-year period. It's the footwear maker's fourth buyback that size since October 2000. It now has 39 million shares outstanding.

"We continue to experience strong operating results and are generating solid cash flow," CEO Timothy O'Donovan said in a statement. "We see additional share repurchases as one of the ways to employ this cash flow and further enhance shareholder value."

CEC Entertainment, operator of Chuck E. Cheese restaurants, said in August it would buy back up to $100 million in stock on top of a $75 million buyback plan approved in February. Security software firm RSA Security said in September it would buy up to 6.7 million of its 64 million shares.

Christopher Tsai, president of New York-based Tsai Capital, likes to see firms in his portfolio repurchase shares. Two stocks he owns, Wal-Mart and Walgreen, have recently announced buyback plans.

"It's a good sign for the stock market because managements are expressing confidence in the underlying value of corporate America," said Tsai. "I think there's a tremendous amount of value in the marketplace, and managements are simply taking advantage of that."