2 Stocks That Are Wasting Your Money

According to Boston University finance professor Allen Michel, when a company announces it's buying back stock, that stock tends to outperform the market by 2% to 4% more than it otherwise would have over the ensuing six months.

But over the long term, multiple studies show that buybacks actually destroy shareholder value. CNBC pundit Jim Cramer cites the example of big banks that bought back shares in 2007-2008 -- just before their stocks fell off a cliff. Far from buy signals, Cramer calls buybacks "a false sign of health ... and often a waste of shareholders' money." Indeed, Financial Times recently warned: "the implied returns over a period from buy-backs by big companies would have been laughed out of the boardroom if they had been proposed for investment in ... conventional projects."

So why run buybacks at all? According to FT, management can use them to goose per-share earnings, which helps CEOs earn bonuses based on "performance." Also, the investment banks that run buybacks earn income and fees from promoting them. But you and me? Unless the purchase price is less than the shares' intrinsic value, we miss out.

And we're about to miss out again.

Two bad buybacks
StreetInsider.com keeps a running tally of which companies are buying back stock, and how much they're spending. SI is too polite to accuse companies of wasting shareholders' money, of course -- but I'm not. With SI's help, I've uncovered two examples of popular stocks that I believe are squandering shareholder dollars on ill-timed buybacks -- and one stock that isn't.

American Capital (Nasdaq: ACAS  )
At first glance, American Capital's recent repurchase of 8.4 million shares looked like the furthest thing from a "bad buyback." This publicly traded private equity firm sells for a cheap 3.8 times trailing earnings, and Wall Street expects it to grow at 15% over the next five years. Best of all, if AmCap ever gets back to paying a dividend to its shareholders... well, if it pays anything like the rates it used to, there could be a big payday in your future.

But that's just the thing: American Capital won't pay dividends at its high past rates, at least not anytime soon. In fact, last we heard, management had basically given up on paying dividends for the foreseeable future. Why? Because AmCap is a bit strapped for cash right now. Revenue has fallen for four years running, and while profitable today, it will be years before AmCap recovers from the massive, $4-billion-plus losses it recorded in 2008 and 2009.

In short, this company really can't afford to pay dividends right now. But this begs the question of why AmCap thinks it can afford spending nearly $60 million buying back its dead-in-the-water shares, and whether that's even a good idea.

Flowserve (NYSE: FLS  )
Speaking of bad ideas: Flowserve warned investors to expect below-consensus earnings in 2012 last month. In order to head off a selloff, though, management quickly reaffirmed its commitment to share buybacks to support the stock price. After spending $150 million of shareholder dollars buying back stock in 2011, Flowserve announced another round of buybacks in 2012. This means Flowserve could spend as much as $300 million on future buybacks.

There's just one problem: Flowserve doesn't have $300 million. It's got just $227 million cash, against a debt load of $510 million. The company also generates less than $100 million free cash flow annually (despite an income statement that claims $416 million in trailing "earnings") -- and has produced similar income-lagging FCF in four of the past five years. Sound like a stock you would double down on?

If not, then I'm guessing you don't work for Flowserve management.

A better use of cash
Now, I never like to end this column on a down note, and fortunately, I have spotted one company out there, that's spending its shareholders' money prudently: Marvell Technology (Nasdaq: MRVL  ) .

Marvell makes chips for many things, but earlier this month, fellow Fool Evan Niu told you about one big project in particular: Marvell is building the brains for Google's (Nasdaq: GOOG  ) latest Google TV. The project is important for Google, which suffered a steep drop in the profitability of its ad business last quarter, and hopes to use its Motorola acquisition as an entree into viewers' TV sets and as a new market for its ads. If it works, this will be good news for Marvell, but it's not the only reason to like the stock.

Selling for 13.5 times earnings, Marvell looks attractive at near-16% long-term earnings growth. Back out its $2.4 billion bank account, though, and it's downright cheap at an ex-cash P/E of just 7.7. Marvell thinks this price is nice, and just upped its buyback authorization to a cool $2 billion. I think it's right to do so.

In fact, I'm so sure Marvell is getting a bargain here that I'm going to grab a (virtual) piece of it for myself. Right now, I'm heading over to Motley Fool CAPS to rate Marvell stock an outperform. Want to see how my bet works out? Follow along.

Looking for more great stock as "buyable" prices? You're in luck, because we've just found five of them. Read all about it in the Fool's new -- and free! -- report: "5 Stocks The Motley Fool Owns -- And You Should, Too ."

The Motley Fool owns shares of Marvell Technology Group and Google. Motley Fool newsletter services have recommended buying shares of Google. Fool contributor Rich Smith does not own (or short) shares of any company named above. The Motley Fool has a disclosure policy.

Read/Post Comments (22) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 24, 2012, at 1:03 PM, villainx wrote:

    Regarding ACAS, this article seems to be incomplete at best or off base at worst. Either way, it's a little irresponsible.

  • Report this Comment On January 24, 2012, at 1:42 PM, gemini26 wrote:

    "Unless the purchase price is less than the shares' intrinsic value, we miss out." This line says it all! With ACAS you are buying significantly below NAV...either you can't read a balance sheet, or you have the wrong company!

  • Report this Comment On January 24, 2012, at 1:55 PM, 0b1knob wrote:

    ACAS decided to buy back shares at the same time that Paulson, a major investor int the company, decided to sell his shares. There was speculation that Paulson intended to break up or sell the company but he was forced to sell ACAS to cover losses in other investments.

    The whole thing stinks to high heaven of insider dealing. How many of the repurchased shares were bought directly from Paulson? Nearly all of them I suspect. The buy back served to keep the current bad management team in place which was all it was ever intended to do.

  • Report this Comment On January 24, 2012, at 2:22 PM, villainx wrote:

    You can correct me if I'm wrong, Paulson sold roughly under 10 million shares, ACAS brought back roughly over 17 million shares.

    Not saying your thesis of insider manipulation is right or wrong.

  • Report this Comment On January 24, 2012, at 3:14 PM, 0b1knob wrote:

    Its difficult to get up to date data on either Paulson's holdings or the number of shares ACAS has repurchased. In December he still held over 38 million.

    http://www.insidermonkey.com/blog/2011/12/28/paulson-grows-b...

    ACAS if buying stock back at a premium to Paulson's average price of a little over $5. Whether the company is buying directly from him or not is irrelevant. If Paulson sold in the open market without the buyback program supporting the price he would have taken a loss.

    Like I said it stinks. Want to bet that the buyback program ends at the same time Paulson sells his last share?

  • Report this Comment On January 24, 2012, at 4:04 PM, ddepperman wrote:

    Ha! The biggest waste of a fool's cash is ATVI which spiked in 2008 at 17.99. Maybe a better use of the money sitting there would be better put elsewhere. If ATVI suddenly rises, there should be time to go there again.

    Sorry Team Dave. ATVI doesn't cut it.

  • Report this Comment On January 24, 2012, at 9:49 PM, r12l4 wrote:

    ACAS is has been trading around 60% of book value. buying back shares is giving way more value to shareholders per dollar than paying a dividend would. Would you rather have 60 cents (dividend), or buy a dollar for 60 cents (share buybuck)? It is true most buybacks are crap, but not when the company is trading below book value...If anyone is being dishonest it is the author of the article, he may be the one trying to manipulate share prices

  • Report this Comment On January 25, 2012, at 1:50 AM, TMFDitty wrote:

    To all the book value-citers, I'll pose just one question:

    Bank of America is selling for 35% of book value -- roughly half the valuation at ACAS. Does this make BAC, too, a no-brainer, obvious bargain investment? You'd better say "yes," because if you don't, the argument that ACAS is de facto cheap because it's sellng for 68% of book falls apart really quick.

    TMFDitty

  • Report this Comment On January 25, 2012, at 9:44 AM, Nailpick wrote:

    >TMFDitty<

    ACAS has far , far less debt to equity compared to your choice of examples, BoA. There is no straight line comparison between the two.

    So, ACAS at a 40% discount to NAV is a "BUY", Boa ? not so much.

  • Report this Comment On January 25, 2012, at 10:22 AM, NotMyBusinessBut wrote:

    The original article is a great example of irresponsible journalism.

    There was no reference in the article discussing ...

    1) ACAS's PR in August which laid-out the dividend vs stock-repurchase. It is as clear as any corporate communication can be that the amounts that ACAS is currently using to buyback is directly attributable to future dividend levels.

    2) There was no discussion of the BV discount as well as the EXTREEMLY low debt/equity ratio.

    3) There was no discussion of the impending expiration of restructured debt that had income-protection provisions (in Aug'12) and the effect that has on ACAS refinancing all the restructure debt.

    4) There was no recognition of ACAS's temporary change to a c-corp in order to retain ordinary losses into this current year and how that relates to the buy-back/dividend strategy short term.

    5) There was no comment on the impending liekly GAAP regulation change that would dictate that ACAS consolidate ECAS on its books, thus removing the highly-volitile discount of ECAS's valuation.

    There was just so much in this article left out that one can only conclude that either the author is was negligent in their research or purposefully misleading in their reporting, neither of which is very flattering.

    NMB

  • Report this Comment On January 25, 2012, at 10:50 AM, spokanimal wrote:

    Excellent commentary, notmybusiness.

    Horrible article, Rich Smith.

    Rich, do you ALWAYS scrutinize the EPS of a private equity company relative to it's balance sheet in the same proportion as one might do so with a company in another industry? Where did you get your CFA, Gomer University?

    TMFditty, same kind of question for you... an apples to apples comparison of price-to-book of BAC and ACAS is about the worst kind of comparison of that nature that you could make...

    ... it's all about the "makeup" of those assets, bud... veerrry different.

    Spok

  • Report this Comment On January 25, 2012, at 10:53 AM, 0b1knob wrote:

    "4) There was no recognition of ACAS's temporary change to a c-corp in order to retain ordinary losses into this current year and how that relates to the buy-back/dividend strategy short term"

    I don't understand how that could be construed as a positive sign. ACAS paid no taxes as a registered investment company , now it pays no taxes due to loss carry forwards? Whatever ACAS lost in the past are sunk costs and there is no way to recover them. As to their "temporary" change, do you know of even one company that has given up its RIC status and then gotten it back? I don't think the IRS would ever allow it. The drastic action of giving up RIC status was taken without any discussion with stockholders. As to their dividend policy all I got from the press release was that they will pay a dividend whenever they feel like it which will probably be never. And god only knows what write downs and losses are concealed in their European operations. Once they are required to consolidate them it may sink the company.

  • Report this Comment On January 25, 2012, at 11:14 AM, NotMyBusinessBut wrote:

    Ob1,

    >> don't understand how that could be construed as a positive sign.

    Have losses carried forward is not the "positive sign" as in "oh, goodie, goodie, they have losses to carry forward" .. (give me a break) ..

    BUT ...

    Changing to a c-corp so that those losses can be used to offset current earnings allows ACAS and its shareholder to retain $$$. So, not a possitive sign to have losses to carry forward .. but a POSITIVE MOVE to find ways to take advantage of them.

    >> do you know of even one company that has given up its RIC status and then gotten it back? I don't think the IRS would ever allow it.

    It's an election that the company makes. As long as they quality, ACAS can simply elect to be taxed as a RIC.

    >> And god only knows what write downs and losses are concealed in their European operations. Once they are required to consolidate them it may sink the company.

    Again, incorrect. ECAS's assets are already being valued by the same standards that ACAS's book is. Consolidating will simply remove the double-discount now applied to those assets.

    NMB

  • Report this Comment On January 25, 2012, at 11:26 AM, NotMyBusinessBut wrote:

    PS .. Ob1

    >> The drastic action of giving up RIC status was taken without any discussion with stockholders.

    Simply an false statement. It was present is several 10q's, the discussed in on at least 2 conference calls as well as discussed it at length during the annual shareholder's meeting (prior to doing it).

    >> As to their dividend policy all I got from the press release was that they will pay a dividend whenever they feel like it which will probably be never.

    Obviously you either haven't read it or can not understand the simple language that is used.

    "Under the newly adopted program, quarterly, American Capital will consider setting an amount to be utilized for stock repurchases or dividends. Generally, the amount may be utilized for repurchases if the price of American Capital's common stock represents a discount to the net asset value of its shares, and the amount may be utilized for the payment of cash dividends if the price of American Capital's common stock represents a premium to the net asset value of its shares."

    http://ir.americancapital.com/phoenix.zhtml?c=109982&p=i...

    Don't know how a company can be any clearer.

    NMB

  • Report this Comment On January 25, 2012, at 11:27 AM, 0b1knob wrote:

    Class action lawsuit against ACAS over its actions

    http://www.pr-inside.com/class-action-lawsuit-on-behalf-of-r...

    More will follow. The company can't take the sort of drastic actions that it has taken without submitting the matters to a shareholder vote. I've tried to bring up some of these issues on the Yahoo ACAS board and my posts keep being taken down. Does ACAS have the ability to take down critical posts? Apparently they do. Thank god for the Motley Fools.

  • Report this Comment On January 25, 2012, at 11:38 AM, NotMyBusinessBut wrote:

    >> Class action lawsuit against ACAS over its actions

    Can you even read your own links? This is old and expired. It never turned into a class action.

    >> I've tried to bring up some of these issues on the Yahoo ACAS board and my posts keep being taken down.

    People often think their posts are taken down on Yahoo, but there is a 'web-bot' that rates all posts with 1-star .. so unless you put your viewer on "1-star or above", you can't see the vast majority of the posts.

    NMB

  • Report this Comment On January 25, 2012, at 11:41 AM, Nailpick wrote:

    NMB

    Thank you for posting factual information concerning the strategy behind American Capital LLC share buyback, RIC election and how these relate.

    TMF has posted this tripe as a valuable insight to the hazards of share buy back, as if all buy backs are alike thus have the same outcome.

    Rick Smith and "TMFditty" ( one in same according ot the profile) is not serving any subscribers of TMF with thoughtful analysis and objective thought anymore than profiling someone for any reason tells but a small part of the whole.

    Bad article not worthy of a serious investor knowledge gathering site. Motley Fool, indeed.

  • Report this Comment On January 25, 2012, at 1:14 PM, TMFDitty wrote:

    For the record: "Nailpick" has made precisely one pick on Motley Fool CAPS. It was ACAS, and he's down 80 points.

    So there.

    TMFDitty

  • Report this Comment On January 25, 2012, at 1:47 PM, NotMyBusinessBut wrote:

    >> "So there."

    Really? "So there."? Now that's mature.

    Ditty, your article was not about whether or not investing in ACAS was a good play. Obviously ACAS and many other stocks are way down since then and fundamentally changed. That was not the issue or topic of your article.

    The issue is whether or not NOW .. at it's current price .. in the context of ACAS's stock buybacks, whether or not ACAS is a good investment.

    Crammer has been negative on ACAS from its lows <$3 and was still calling people away <$2. Certainly, in retroscpect, that wasn't a good call.

    If you want to be treated like a financial reporter who garners any amount of respect, you might consider posting your responses like one.

    NMB

  • Report this Comment On January 25, 2012, at 1:56 PM, NotMyBusinessBut wrote:

    Edit ..

    >> Ditty, your article was not about whether or not investing in ACAS was a good play.

    I meant to type ".. investing in ACAS [prior to the financial crisis] was a good play .."

    NMB

  • Report this Comment On January 25, 2012, at 2:39 PM, Nailpick wrote:

    TMFDITTY also Rich Smith, correct?

    Your right I have been in ACAS for 12 years now. Sold my entire holding during the "great recession".

    The first seven years doubled my original stake ( not including the dividends paid over those seven years) before selling at 80% below high that year. Since then I recouped all the loss and now hold a considerable amount of "free" shares at todays price.....

    So what does that have to do with your comments?

    You are the writer of this article, correct?

    You printed an incomplete picture of ACAS. That is not worthy of being posted and sent out to other public investor sites as analytic advice. Poor form on the part of the Fool, but then it appears it achieved a link to the Fool site, which is all they were looking for.

    Once again , bad article , not worthy of an investor educational site.

    Nail

  • Report this Comment On January 25, 2012, at 5:43 PM, JeremieP1 wrote:

    Horrible article. How can you make this argument without at a very minimum discussing buybacks when price is at a discount to NAV?

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