Tags: Hudspeth | stock | buyback | dividend

StreetAuthority's Hudspeth: Sometimes Share Buybacks Can Be an Investor Trap

By John Morgan   |   Monday, 18 Aug 2014 02:58 PM

Some American companies are using share buybacks to disguise the fact that their underlying businesses are eroding, according to StreetAuthority columnist Christian Hudspeth.

Since 2009, the 500 largest U.S. companies have boosted buyback spending by 245 percent, compared with only 60 percent growth in dividend payments since then.

"This isn't a bad thing — share buybacks can be one of the single most effective value-boosting measures a company can take to reward shareholders," Hudspeth wrote.

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When companies reduce their total share count through buybacks, it tends to make the remaining shares more valuable by driving up the stock price.

"But be warned: Just because many large U.S. companies have been repurchasing shares doesn't mean they all have the best of intentions for their shareholders," he noted.

In fact, some companies use buybacks to lure in less-informed investors, Hudspeth argued.

"Buybacks boost a company's earnings per share. So, many large companies with stagnant or falling revenues in previous years have been using share buybacks to inflate their profitability image."

As an example, he noted IBM has purchased 200 million of its own shares since 2010, slashing its outstanding shares by 16 percent.

"But at the same time, the company's annual sales have stayed flat over the past four years. In fact, the company's revenue over the past 12-months are actually lower than they were in 2010 — $98.8 billion now compared to $99.8 billion in 2010."

He also cited Monster Worldwide, a company that has bought back 25 percent of its shares during the past year, but the company's revenues plunged to $800 million in 2013 from $1.3 billion in 2008.

"The value added per share from these buybacks have no doubt made some shareholders happy, at least for now. But it remains to be seen if investors will remain optimistic with large companies like these that aren't actually growing their top lines — buybacks or not," Hudspeth wrote.

"Bottom line, always remember that buybacks are great, but only if they come from a company that has a growth plan and is ultimately enhancing shareholder value — and not simply trying to attract the attention of foolish investors that follow flashy headlines."

A new survey from the American Association of Individual Investors showed some investors are growing skeptical about the value of share buybacks, according to Forbes.

"Though the responses varied, one theme appeared regardless of a member's opinion about buybacks: Other uses of cash should be given priority before shares are repurchased," Forbes noted.

Specifically, approximately 17 percent of those polled said that dividends or growing the business should take precedence over buying back stock.

Business Insider CEO Henry Blodget, meanwhile, predicted that when companies slow down the pace of their share buybacks, as seems inevitable at some point, it could have an adverse impact on the stock market.

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