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.

International Business Machines (NYSE: IBM  )
When investors didn't respond to IBM's last earnings report as enthusiastically as hoped, management reached into its bag of tricks and came up with a perennial favorite: a $7 billion stock buyback. This got a positive reaction on the Street, but should it have?

After all, it's not as if this was a new idea. To the contrary, IBM tried this same buyback gambit last year -- and for the same amount: $7 billion. Back then, I warned investors that at 15 times earnings, and 12% projected growth, IBM was fairly priced, but not an obvious bargain.

And what's happened since? Like most stocks on the Dow Jones Industrial Average, IBM has given up all its gains from earlier this year and is now basically flat. The P/E has shrunk to around 14, but so have analyst estimates for IBM's growth prospects -- to just 10.6% annualized over the next five years. Toss in a modest 1.8% dividend, and IBM remains no more than a so-so bargain.

JPMorgan Chase (NYSE: JPM  )
A second "returning player" to this column is international megabanker JPMorgan, last discussed here in our Dec. 27 column. Back then, JPMorgan was trying to win some brownie points with a $950 million boost to its buyback plan -- a plan I panned as too aggressive, given the potential for JP needing the cash to cover unforeseen risks. Yet instead, the bank came back in March to announce a truly massive $15 billion repurchase plan.

So how did that work out? JP's gone on quite a wild ride since late December, rising as high as $46 before closing Friday a buck lower than it began. It returns to us with a bigger dividend yield, but a similar valuation (seven times earnings), and weakened growth prospects in the wake of its $2 billion "London Whale" loss announced last month.

I didn't agree with the $15 billion repurchase any more than I did the smaller December plan, obviously. But now, JPMorgan CEO Jamie Dimon has admitted that he now sees the error of his ways. The "unforeseen risk" has become blindingly obvious, and dealing with it requires that JP suspend its buybacks in order to meet regulatory capital requirements.

Western Digital (Nasdaq: WDC  )
Now I don't like to end this column on a down note, and fortunately, there is one company out there that may do better by its shareholders: Western Digital.

Last week, analysts at Barclays downgraded both Western Digital and its archrival in hard-disk-drive-manufacture, Seagate (Nasdaq: STX  ) , arguing that tepid demand for personal computers would hobble the companies' immediate prospects and prevent quick gains in share price. To which I reply: "Great!"

Last month, you see, Western Digital announced $1.5 billion in new buybacks. And the lower the stock price when these buybacks actually happen, the greater the bargains Western D's management can snag -- for itself and its shareholders. Here at the Fool, Western Digital may not be our absolute favorite stock (read about who is in this free special report). But at just seven times earnings (and an even cheaper price-to-free cash flow ratio), Western Digital is one of the cheapest stocks on the market if it can hit projected annual earnings growth rates of 21% annually. But in fact, Western D could miss that target by a mile and still be a bargain. Twenty-one percent, 11%, 1% -- even with no growth at all, seven times earnings is a crazy low price, and Western Digital management would be crazy to pass up the chance to buy back shares at this valuation.

Fact is, once the Fool's trading rules permit, I may just pick up a few shares of this rock-bottom-priced stock myself -- 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 Western Digital, JPMorgan Chase, and IBM. Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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  • Report this Comment On June 04, 2012, at 2:26 PM, havoc007 wrote:

    If you think WDC is cheap at a PE of 7, you should check out its rival Seagate. It trades at a forward PE of 2. Yes TWO. I believe it is the cheapest stock in the entire stock market. Both companies are trading like their going bankrupt. Seagate also has a $3.5 billion buyback. Enough to retire 30% of its shares. It currently has a quarterly cash flow of $1 billion per quarter. With a market cap of $9 billion, Seagate could take itself private in less than 2 years. I am a monkeys uncle if Private Equity is not circling both of these companies. They will double their investment in less than 3 years (assuming they re-IPO).

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