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What buybacks mean for you?

June 29, 2013

Yesterday Pfizer announced a $10B share buyback program along with its quarterly dividend – Pfizer now joins the growing ranks of companies that have announced share buyback over the last several years: Wal-Mart, Apple, and J.P Morgan are other large, well established house hold names that have announced multi-billion buyback programs. But what exactly does that mean? Put into simple English a share buyback is when a company offers, though a proxy (another word for representative), an offer to purchase shares of stock back from the individual shareholders. In essence, they are “buying back” the stock that is currently being held by outside owners.

Firms do this for a few reasons: the one you most often will hear on T.V. is that management feels that the stock is undervalued, and this is the best way to create shareholder value. There is, however, a slightly more cynical way to view these announcements: a lot of metrics that companies are graded on use the number of shares outstanding as the denominator. Let’s use EPS (earnings per share) as a quick example.

Company ABC is projected to earn $10 million this year, and has 10 million shares outstanding so it’s EPS is $1/share, but what if the analyst estimates are $1.05/share? If ABC comes in at only $1/share that is going to make a lot of shareholder unhappy and could lead to heavy selling of the stock – not a good day to be management at ABC.

So how can we help ABC meet its EPS target? Well one way is to announce a buyback program – if ABC buys back 500,000 shares during the year and nothing else changes their annual EPS will increase to $1.05.

 $10,000,000/9,500,000 = $1.05

 Everyone is happy.

 Wait, buying back those shares costs money, and depending on the company we are talking about it can add up to tens of billions of dollars that are being spent on this buyback. Is that really the BEST use of the company’s money; is that the BEST way to create shareholder value? If that really is the best idea that management to come up with to improve earnings, and not anything related to the actual operations of the firm then management may have bigger problems than my blog post.

 I’m not saying buybacks are bad in and of themselves, but I know that whenever I see one announced I dig deeper: the history of buybacks shows that for the most part company management buys back stock at near peak prices when it costs the most money to do so. Over-paying for something never is the best way to create shareholder value. Period.

 Food for thought!

 

 

 

 

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