With stock prices felled by the turmoil in financial markets, many companies are out to revive their stock by announcing they’ll buy back shares.
This is typical when investors punish stock prices because company executives see it as an irrational overreaction.
Finance experts who’ve studied buybacks say they are generally good news for investors because they help to shore up the price of a stock and create a positive reaction when times are tough.
“To that extent, it’s symbolic,” said James Westphal, professor of management at the University of Texas, who wrote a report on buybacks. “It sends a signal that the company is undervalued and that top managers are concerned about shareholder value.”
Whether the stock of companies offering buybacks outperforms those of their peers not offering buybacks depends on several factors, said Michael Mauboussin, an analyst with investment bank Credit Suisse First Boston in New York, which recently issued a report on the subject.
Those include how many shares a company intends to buy back, what premium it’s willing to pay for the stock and whether management is selling its holdings.
At the same time, if stock options attract top talent to a company, that’s good for its stock because it would eventually translate into a higher stock price, Mauboussin said.
But just because companies say they’ll buy back shares doesn’t mean they’re going to do it.
Westphal considered 412 major corporations that announced buybacks between 1985 and 1991. In the five years after the announcement, 38 percent of the companies didn’t buy back any of their shares and 66 percent didn’t repurchase all the shares they said they would buy.
The reason they don’t follow through is that once a company has telegraphed that it believes its stock is undervalued, “the purpose of the plan has been accomplished,” Westphal said.
There are several factors that can trigger a buyback announcement from a company, according to Credit Suisse:
– The company believes its shares are worth more than the market believes. When a company buys back its stock, it reduces the number of shares outstanding, thereby bolstering the per-share price of the stock. By shrinking the number of shares, a buyback boosts per-share profits unless profits also decline.
– To soak up shares pouring into the market because of stock options to employees. “Managers generally prefer to avoid an upward creep in the share count as a result of stock options,” Credit Suisse said. “Share buybacks offset this embarrassment of riches.”
– To redeploy excess cash. A company generates surplus cash when its earnings exceed its investment opportunities. It may want to use the extra money to buy back its stock if it doesn’t find a better use for the money.
– To gather the shares to offer targets of future acquisitions. That’s one of the reasons cited by Vern Stockton, spokesman for Bank United in Houston, who said the bank holding company believes its stock is a good investment.
It’s important to see if a company has followed through with a buyback because that tells you how sincere it is. Some companies will announce the completion of a buyback either in a separate announcement or include the news when it announces another buyback. Many companies also announce completion of buybacks in earnings reports.
You may also call a company’s investor relations department and ask whether a firm has completed a buyback program.
If a company hasn’t followed through on a buyback announcement, you want to know why because it may be that it’s found a better use for its money.
One tipoff that a company may not follow through is the number of board members who are from inside the company, Westphal said. The more independent the board, the better. “Where managers sit on other boards that have announced and not implemented buybacks, they are more likely to do the same thing (at their own companies),” Westphal said.
