Shrink! Buybacks of 5 Undervalued Stocks

Stock buybacks are generally considered a bullish signal on Wall Street. Buybacks often proclaim management's belief that its stock is cheap and that shares of its own company will provide its best return on investment. Like dividends, buybacks also let companies return capital to shareholders.

How buybacks work
Done right, share repurchases will increase earnings per share, as long as profits stay at least at the same level. A company with $1 million in earnings and 1 million shares outstanding will have earnings per share of $1. Now, if it buys back 250,000 shares, leaving only 750,000 shares outstanding -- and total profits remain $1 million -- its new EPS would be $1.33, or $1 million divided by 750,000.

We're seeking companies that have announced stock-buyback programs. Then we'll head over to Motley Fool CAPS to get some insight into the investor community's preferred picks. If companies announce stock buybacks, and CAPS' top investors endorse their future prospects, Fools should take notice.

Here are some of the latest companies to announce share-repurchase programs.

Company

Buyback Announcement Date

Amount of Buyback

CAPS Rating (Out of 5)

Alcoa (NYSE:AA)

10/9/07

217 million shares

****

Yum! Brands (NYSE:YUM)

10/9/07

$1.25 billion

****

Avon Products (NYSE:AVP)

10/12/07

$2 billion

***

C.R. Bard (NYSE:BCR)

10/10/07

$500 million

*****

Journal Communications (NYSE:JRN)

10/9/07

5 million shares

**

Sources: Company press releases, Motley Fool CAPS.

The CAPS advantage
Investors at CAPS seem to have pretty upbeat opinion about this group of companies announcing buyback programs -- four of the five companies are earning average ratings or better.

Aluminum producer Alcoa lost out to U.K.-based Rio Tinto (NYSE: RTP  ) in the battle to acquire Canadian counterpart Alcan (NYSE: AL  ) . Since a consolidation mood still prevails in the industry, Alcoa may be a vulnerable target to others. That may be why it upped its buyback plan. and is the basis for CAPS All-Star ennui's positive outlook:

Alcoa didn't win its bid for Alcan, and that left it as a smaller player in the aluminum industry--and now a target for another company to acquire. An attractive company on many levels. Certainly a fair bargain at the price at which I recommended it. If you can get it cheaper (as I did in the August sell-off), so much the better.

The company's earnings miss -- driven in part by higher fuel costs and a weak dollar -- means that it needs to continue cleaning up its balance sheet. Divesting more assets -- as seen with its previously announced Reynolds division -- and reducing employee levels should keep investors happy going forward.

It's the fundamentals that make StockSpreadsheet, an All-Star with a 91.60 player rating, believe Alcoa is a buy:

Average annual sales growth of 10% over the last 4 years. Average annual EPS growth of 32% over last 4 years. Pretax profit increased last year, after being relatively flat the previous 4 years. EPS/book value increased last year, after being fairly flat the previous 3 years. Their debt-to-equity ratio has been fairly flat the past three years, averaging about 40%, which is reasonable, though I would prefer to see it declining. Their current P/E ratio is below their trailing 3 year average, which is good, though it is above the highs reached last year, which is of some concern. Their current payout ratio is 25%, which is reasonable, so their dividend, currently yielding 1.5%, should be secure. Their trailing 4 year average PEG ratio is a very reasonable 0.52. I think this stock could reach $148.00 in five years, or about triple the current price of $47.35, though I would consider selling some of my position if it hit $112.00 or more in the next 4 years. Add in a decent dividend yield and I think this stock is a buy.

Foolish fallout
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