With the stock market hitting multiyear highs, everyone's excited about the future for stocks. Even corporate boards of directors, who should know better, have started getting wrapped up in the hysteria of the moment -- and if they're not careful, they'll repeat a mistake that their predecessors have often made.
Companies often face challenges putting their free cash to work. With cash investments paying very low interest rates, a soaring stock market exposes the opportunity cost of holding cash, rather than investing it. In response to that pressure, many companies have ramped up their stock buyback programs, in some cases authorizing billions of dollars toward repurchasing shares. Here are the biggest buybacks from the past couple of months:
Amount of Buyback
2-Year Average Ann Return
||Jan. 25||$1.5 billion||96.2%|
||Jan. 24||$10 billion||29.6%|
Bed Bath & Beyond
||Dec. 21||$2 billion||42.4%|
||Dec. 17||300 million shares||12.1%|
||Dec. 13||$2.5 billion||(4.6%)|
||Dec. 13||$1 billion||19.8%|
Source: Online Investor, Yahoo Finance.
As you can see, there's a real hodgepodge of performance figures associated with these stocks. Some of them have gone nowhere, and management clearly believes that shares are bargains. But many of the stocks have skyrocketed since 2009's lows, and buying them only after these big gains may not be the best use of spare cash.
The wrong time for the right move
Stock buybacks often prove to be spectacular failures in terms of timing. A recent article in Barron's shows the mistakes that many major companies, including General Electric, Bank of America, and Merck, made with ill-timed multimillion-dollar buyback authorizations.
Two things may account for the difficulties that corporate boards face in deciding when to do buybacks. On one hand, it's easier for executives to spend their company's money than their own, so the incentive to be smart with the cash isn't quite as direct as it would be otherwise.
A less cynical explanation also plays a factor. The best time to buy back shares is when a company's stock is cheap, but those are also likely to be the times when the company is least able to spare the cash. Conversely, during good times, companies are flush with cash, but that's when shares are most likely to be richly valued.
The anti-insider effect
When it comes to picking stocks, smart investors often look for insight from those who know the companies best. Many look for signs of insider buying among company executives and board members, figuring that with their intimate knowledge of the companies they work for, their confidence in putting their own money at risk bodes well for a stock's prospects.
You'd figure that when companies approve share buybacks, you could count on the same effect. After all, you might assume, if a board didn't think the shares were a bargain, then they wouldn't spend hard-earned cash on them, right? By reducing the number of outstanding shares, buybacks grant each remaining share a bigger piece of the earnings pie, improving earnings per share and presumably raising stock prices as a result. But if they have bad timing, all that money can end up being wasted.
Not all companies goof up their share buybacks, though. CEO Steve Wynn of Wynn Resorts
Despite the attention that stock buyback announcements always get, they don't necessarily deserve all that much consideration. Unless your company's management has a strong track record of buying back shares at smart times, bidding up a stock because of a buyback is a short-sighted move.
Don't count on management to make smart purchases with your money; find great stocks on your own. Read our special free report "The Motley Fool's Top Stock for 2011" and learn about one smart stock that could be exactly what you're looking for to start your portfolio off on the right foot. Get instant access by clicking here -- it's free.