Is Your CFO Sleeping Around?

Before you get too excited (or nervous, if you're a philandering CFO), let me make myself clear: I have no special insight into the sex lives of corporate executives, and -- despite my repeated requests -- The Motley Fool stubbornly refuses to cover celebrity gossip. However, I do have an insight that could help you make a lot of money in the stock market, as well as a clever analogy to justify my salacious title. I'll get to that analogy in a moment, but first, let me set the stage.

Best Buy or bad decision?
Along with a better-than-expected earnings report to close out its fiscal year, Best Buy (NYSE: BBY  ) proudly announced that it plans to buy back up to $2.5 billion of its common stock on the open market. This news was immediately embraced by investors, who sent the stock up about 4% following the announcement. However, a closer look at the electronic retail giant's history suggests that Best Buy's renewed interest in share repurchases should probably be cause for concern rather than celebration:

Fiscal Years*

Amount Spent Repurchasing Shares
(in Millions)

Best Buy
Share Price Range

1999, 2000


$6.16 - $32.77

2001, 2002, 2003


$9.26 - $35.68

2004, 2005


$16.59 - $39.09

2006, 2007


$30.68 - $56.05



$41.20 - $51.65

2009, 2010


$17.08 - $46.25

Data from Capital IQ and Yahoo! Finance.
*Best Buy's fiscal year ends on the last Saturday in February.

As you can see from the table above, Best Buy began buying back its shares in the late '90s, but ceased once the Internet bubble burst. A few years later, the company tentatively resumed its repurchase plan, accelerating the pace aggressively when the economic coast once again appeared clear. However, after the credit crisis clobbered the stock two years ago, the company did not repurchase a single share.

Only now that the worst appears to be behind us and the stock has rebounded back near its two-year high is Best Buy willing to open its coffers once again. Management may not have destroyed value with its repurchases, but shareholders should wonder why more weren't made when prices were depressed.

Misery loves companies
Unfortunately, Best Buy is far from the only company whose executives have made ill-timed repurchases. Sears Holdings (Nasdaq: SHLD  ) repurchased nearly $3 billion worth of shares near the market peak in 2007. Between 2004 and 2008, Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) combined to buy back more than $55 billion worth of common stock. Think they'd like a do-over?

And while those capital allocation atrocities make Whole Foods' (Nasdaq: WFMI  ) botched buyback seem like peanuts, it's important to consider the context here. In the first quarter of 2008, Whole Foods bought back $200 million worth of shares at about $44.40 apiece. But later that year, when the company needed capital in the midst of the credit crisis, it was forced to issue $413 million in preferred stock -- at just $14 per share. You don't need an MBA to conclude that Whole Foods' shareholders got a raw deal.

If you're a shareholder of any of these companies, keep their track record in mind the next time they announce buybacks.

Rest assured, there will soon be additions to this share repurchase hall of shame. According to data provided by Dealogic, buybacks at S&P 500 companies surged in the first quarter of 2010, up nearly eight-fold from last year's levels. Will (Nasdaq: AMZN  ) or Lowe's (NYSE: LOW  ) live to regret its ramped-up repurchase authorization? I think Lowe's is trading at a discount to intrinsic value, so the buyback could create value for shareholders. Unfortunately, I can't really say the same for Amazon.

I'd really like to hear about promiscuous CFOs now, please
So what in the world do value-destroying share repurchase programs have to do with a CFO's sex life? More than you might think.

Stern School of Business professor Aswath Damodaran has compared companies that sporadically repurchase stock with people who engage in casual sex outside the context of a romantic relationship. "Companies are increasingly addicted to hooking up with stockholders," Damodaran says. "They don't want a long-term relationship."

In other words, you can count on companies like Best Buy to repurchase shares if it's convenient for them, when the future appears rosy and the balance sheet is flush with cash. But when the future is less certain and the company's shares are trading at a discount to intrinsic value -- the time when buybacks would benefit shareholders most -- these companies tend to stand their shareholders up.

"Stock buybacks are like hooking up," Damodaran says. "Dividends are like getting married."

Till death do us part
If you'd like a stock that will return value to you through thick and thin, consider investing in a company that rewards its shareholders with steady dividend payments. As Damodaran notes, dividend payments are far stickier than share repurchases; they're more likely to stay constant (or even increase!) during tough economic times. Importantly, executives are typically committed to keeping their company's dividend intact, which means they're more likely to focus on preserving cash, and far less likely to engage in value-destroying behavior.

But the best reason to invest in dividend stocks is simple: Over time, a dividend-focused strategy has been proven to beat the market, with lower risk. According to Wharton professor Jeremy Siegel, a portfolio of the highest-yielding dividend stocks in the S&P 500 would have produced an annual return of 14.2% from 1957 to 2006, compared with an 11.1% annual return for the index as a whole.

At Motley Fool Income Investor, James Early and his team have scoured the stock market to find the world's 50 best dividend stocks. Since the service began in 2003, 75% of its picks are beating the market, and current recommendations post an average yield of 4.4%.

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Rich Greifner occasionally hooks up with the Fool's disclosure policy. Rich does not own shares in any company mentioned in this article. The Motley Fool owns shares of Best Buy. Best Buy and Lowe's Companies are Motley Fool Inside Value recommendations., Best Buy, and Whole Foods Market are Motley Fool Stock Advisor picks.

Read/Post Comments (2) | Recommend This Article (7)

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  • Report this Comment On May 13, 2010, at 4:00 PM, gregmilano wrote:

    Very useful and timely commentary - thank you. we have researched this area considerably.

    During the economic and stock market boom of the 2000’s, it became quite fashionable for corporations to repurchase their own stock. The companies in the S&P 500 spent over $1.8 trillion on repurchases in the latter half of the last decade – more than 2.5 times the amount repurchased in the first half. For many companies, this use of cash flow crowded out more productive investments in the business such as R&D and capital expenditures.

    The timing of share repurchase activity is often at odds with the “buy low and sell high” axiom. When the stock market peaked in 2007, the S&P 500 companies bought back nearly $600 billion in stock which consumed 64 percent of all the cash they generated from operations. The market dropped by more than half through the trough in 2009, yet faced with the opportunity to buy back twice as many shares per dollar, on average, companies instead cut share repurchases to 10 percent of cash from operations.

    The recovery appears to be underway and companies are hurrying to repurchase shares. In the first quarter of 2010, over 100 companies have announced new or increased share repurchase programs. But if buybacks continue to absorb a bigger and bigger share of cash flow in each business cycle, many companies will see erosion in their competitiveness and shareholder value.

    While some of this buyback activity was warranted, it appears the pendulum has swung too far. Many companies have elevated buybacks to a high priority in the capital deployment pecking order and in many cases; have constrained their reinvestment strategies to fit their buyback plans.

    Our research shows that those buying back more stock over the last decade performed worse for shareholders. We studied the 1000 largest non-financial US companies as of the end of 2009, excluding those not public for the entire 10-yr period of the study, for a sample size of 765 companies. Companies in the top quartile in terms of percentage of cash flow deployed to buy back shares delivered a median total shareholder return (TSR) that was 85 percent lower than the companies in the lowest quartile, which deployed little or no cash toward buybacks.

    Companies with a higher reinvestment rate, that is those that invested a higher proportion of available cash flow toward business investments such as R&D and capital expenditures, created more value for shareholders. Companies in the top quartile on the reinvestment rate delivered median TSR that was 72 percent higher than the bottom quartile.

    We have replicated this research for various rolling five year periods going back to 1997 to see if there are differences in bear and bull markets. We have also studied several industries in isolation. The numbers do change a bit but directionally the message is the same: investing in the business trumps buybacks regardless of the market environment.

    With these clear findings against buybacks, why do investors clamor for buybacks so often? Do they not trust management with the money – fearing any excess cash or debt capacity will burn a hole in management’s pocket and become the “strategic reason” to make an undesirable or overpriced acquisition? Or is it simply that they fear and resist change? There may be many different reasons, but management must have the fortitude to withstand these pressures when they see good opportunities for investment in the business. They must trust that the market will recognize the wisdom of the investment strategy, though perhaps not immediately (or verbally).

    Gregory V. Milano

    Co-founder and Chief Executive Officer

    Fortuna Advisors LLC (a value-based strategic advisory firm)

  • Report this Comment On May 14, 2010, at 2:02 AM, weslindsey wrote:




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