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 multiple studies show that over the long term, 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.

Nike (NYSE: NKE  )
Nike announced the date for its fiscal first-quarter 2013 earnings release on Sept. 13. A week later, the company announced it would buy back $8 billion worth of shares (on top of a previous authorization of $5 billion already under way). Anyone wondering about the timing didn't have to wait long for an explanation, because within just one more week, the earnings news came out: Profits dropped 10% year over year, with profit margins down "across the board."

Nike shares immediately fell below $95, completing a round trip from their Aug. 16 closing price. For a company looking to repurchase shares, they had dropped to their best price in a month... but is this price good enough for you?

Probably not. Right now, shares of this projected 8% grower cost nearly 20 times annual earnings -- a pretty steep price, even before you notice that Nike's free cash flow rarely reaches the lofty heights of "net income" claimed on its GAAP financials. Fools, there's good reason Nike shares have underperformed the S&P 500 by 20 percentage points over the past year: They've been overpriced for a long time, and they're still too expensive today.

Suncor Energy (NYSE: SU  )
Next up: Canadian oil sands specialist Suncor. I'm reluctant to criticize this one, because Suncor has actually done everything I hoped it would. Back in April, I praised this oil producer for delivering real free cash flow after years spent burning cash. Investors have rewarded Suncor, bidding its shares up 38% over the past year.

But in promising to buy back and cancel "up to $1 billion" worth of its common stock, Suncor now faces the prospect of overpaying for its now-pricier shares. Despite growing strongly, Suncor's free cash flow  still lags reported net income ($4.4 billion) by about 10%. Meanwhile, the company's 11.6 P/E still doesn't look attractive relative to a projected growth rate of just 4%. For context, rival ExxonMobil (NYSE: XOM  ) offers a lower P/E, a richer dividend -- and a growth rate twice that of Suncor.

Maybe instead of buying back its own stock, Suncor would be better off taking a small stake in Exxon.

CVS Caremark (NYSE: CVS  )
With a share price that's gained nearly 50% over the past year, and that's outperformed the market by about 20 points, you might think that now is an odd time for CVS Caremark to be announcing a buyback, too. But really, for a company this good, and a stock this cheap, there's never a better time than the present.

Priced at 13 times free cash flow, and with a 13% projected growth rate, CVS fits the definition of a "fairly priced stock" to a T. Recognizing this, CVS announced last week that it is accelerating its planned $6 billion share repurchase program, working with Barclays (NYSE: BCS  ) on a plan to help it buy back $1.2 billion worth of its shares over the next three months.

A side benefit of the program is that CVS will no longer have to pay a 1.3% dividend on the shares it buys back -- a guaranteed return on investment, if only a small one. Meanwhile, the rest of us investors can count on a guaranteed $1.2 billion worth of share buying to help keep CVS' share price on top through the end of this year.

Fool contributor Rich Smith holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services have recommended buying shares of Nike. Motley Fool newsletter services have recommended creating a diagonal call position in Nike. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (5) | Recommend This Article (5)

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.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2040723, ~/Articles/ArticleHandler.aspx, 10/23/2014 4:04:06 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement