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%-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, the 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  )
Three months ago, I criticized American Capital's decision to repurchase 8.4 million shares of stock, even as I admitted that at just 3.8 times annual earnings, the shares looked anything but expensive. With revenues on the decline, AmCap had been forced to cancel its dividend, and as I argued at the time: "this company ... can't afford to pay dividends right now. [So why was it] spending nearly $60 million buying back its dead-in-the-water shares?"

Ordinarily, you'd expect buying activity to support the stock, as management stepped in to buy anytime share prices dropped. So how has that worked out? Well, over the past three months, AmCap shares are up 5%. That sounds good, but it only paces the performance of the S&P 500, also up 5%. Worse, we recently learned that AmCap bought another 5.5 million shares in Q1 2012. Unfortunately, the prices it paid averaged $8.79 per share -- more than 4% above today's going rate.

If at first you don't succeed, fail, fail again.

Goldman Sachs (NYSE: GS  )
And speaking of failures, let's turn to Goldman Sachs. The most (in)famous banker of the 2000s is getting pilloried today in the pages of The Wall Street Journal for letting Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) outfox it on a bond trade involving debt of struggling newspaper company Lee Enterprises. But that's not the only reason to doubt the stock's prospects.

In a cryptic note, Goldman confirmed last month that after the most recent round of bank stress tests, it now has a green light from the Federal Reserve to proceed with a planned "repurchase of outstanding common stock" of unspecified size. Depending on the size, this could be a disaster of either minor or major proportions for its shareholders. Consider: At $119, Goldman shares currently fetch the princely valuation of more than 26 times earnings, while rival bankers Morgan Stanley and JPMorgan cost less than 15 and 10 times earnings, respectively. Yet according to analysts who follow the stock, the fastest Goldman can hope to grow its earnings long term is about 15% per year. The resulting PEG ratio of nearly 1.8 suggests Goldman is overpaying for its shares.

Don't make the same mistake yourself.

Apple (Nasdaq: AAPL  )
Now, I don't like to end this column on a down note, and fortunately, I have spotted one company out there that may do better by its shareholders: Apple. Perhaps you've heard of it?

Last month, it was Apple's initiation of a $2.65 per share dividend that got all the headlines. Less noticed, though, was the i-everything company's announcement that it will also buy back $10 billion worth of stock, beginning on Sept. 30. At first glance, I have to say I like the idea. Priced at less than 18 times earnings (and an even more attractive ratio to free cash flow) and growing at 20% per year, Apple shares look priced to move. My one concern here (I have others elsewhere) is Apple's acknowledgement that a prime objective of its buyback plan is to "neutralize" the effects of future stock dilution from employee equity grants. To the extent Apple uses its buyback authorization to buy undervalued shares and benefit outside shareholders, I like the deal.

But to the extent that Apple spends $10 billion to mask the effects of stock dilution, I don't.

Looking for more great stocks priced at "buyable" prices -- without the stock dilution caveats? 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."

Fool contributor Rich Smith does not own (or short) shares of any company named above. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of JPMorgan Chase, Apple, and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway, Goldman Sachs, and Apple, as well as creating a bull call spread position in Apple. Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (3) | Recommend This Article (9)

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 April 16, 2012, at 3:57 PM, Stanleydb wrote:

    Your comments on ACAS and AAPL are ludicrous.

    You seem to want to judge buybacks on whether the motivation is commendable by your standards rather than whether consequences are good for shareholders. ACAS is buying stock back only as long as it is selling at a discount to NAV. The stock has a huge tax loss and is selling at a crazy low price. The positive effects of these buybacks will be seen in the price before too long.

    Apple should have been buying back stock all along the past several years. That is still true today -- its valuation is cheap by any metric if you assume the company will continue to grow rapidly. If they bought back stock previously to offset share issuances to employees like Tim Cook, how would that have been a bad thing (despite your dislike of this rationale)? It wouldn't.

  • Report this Comment On April 17, 2012, at 1:47 PM, indiobravo wrote:

    You are quite late for April's fool jokes. Business Development Companies use to trade very close to Net Asset Value (NAV), in the case of ACAS, it has been, historically, one or two cents above NAV.

    ACAS' NAV is almost $14, while the stock trades at $8.75. Repurchasing shares at 37% discount and (at the very same time) repay debt, seem to me very wise.

    I consider the stock repurchase as a "non-tangible dividend reinvestment", which I calculated at 6.75% during 1Q. Meanwhile, ACAS management repayment of debt doubled the stock repurchase.

    Management is commited to mantain the stock repurchase until the end of 2012. I hope they keep it going until the stock price equals NAV and debt had been repayed.

  • Report this Comment On April 20, 2012, at 10:59 AM, villainx wrote:

    In regards to ACAS, the arguments continuously given by Rich are just so weak, even disingenuous. There are valid reasons to poo poo the ACAS buyback, such as using the funds to find new business or retire more debt, which might return value and or restore confidence to investors to bring the share price closer to NAV.

    But what Rich argues, that ACAS stock buyback is a bad idea because the day to day ACAS stock fluctuation (or performance over the past three months) isn't outpacing the S&P 500 is kinda ridiculous. Does the fact that ACAS current April 20th share price is $9.00 suddenly make the buyback decision an okay idea. And then if it slips back to 8.79 on Monday it becomes a bad idea again. And so forth.

    Shouldn't the analysis be based on the long term value implication of the buyback (and ACAS management decisions)? Isn't there someone on the editorial board here that, you know, looks over this sort of stuff?

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