Gillette's New Buyback

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Mach 3 maker Gillette (NYSE: G) last night announced a new stock buyback program, with the company's board authorizing the repurchase of 50 million of its own shares -- as well as another 7 million from its previous buyback program. (The old program allowed for 150 million shares to be bought back -- the company spent approximately $5 billion doing just that.)

When high-profile companies announce buybacks, it's a good time to discuss exactly what they should -- and shouldn't -- mean to investors. (For a broader look at Gillette, revisit a recent article by Rick Aristotle Munarriz.)

The "good" of buybacks is very simple: It's a use of capital by a company's management, and should be treated as nothing more or less. Consider that with Gillette's shares currently at more than $32 each, 50 million would cost a tidy $1.6 billion. A company can do a lot of things with $1.6 billion, and investors should only expect their company's management buy back shares when they are undervalued.

Anything else is a waste of money, pure and simple. (More discussion of this, including quotes from Warren Buffett, is in a November article by Zeke Ashton, helpfully titled "The Power of Buybacks.")

That brings us to the flip side of buybacks. All buybacks, by their nature, are theoretically useful in that they reduce (duh) the number of shares outstanding, thus boosting earnings per share. Unfortunately, this isn't done by improved operating performance and net income -- it's just a mathematical trick, and one that costs money.

This is one reason we encourage investors to focus on net income as it pertains to cash flow, rather than making it the end-all number of your analyses. (Ideally, cash flow should be equal to or greater than net income -- or at least showing signs of becoming so over time.)

You can reach Dave Marino-Nachison at DMarnach@Fool.com .