2 Stocks That Are Wasting Your Money

Your company's buying back stock? Hurray! Or should that be "boo"?

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, the Financial Times  recently warned that "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.

Coca-Cola (NYSE: KO  )
Coca-Cola tried to spin a 1% sales gain into a tale of a "strong third quarter " last week, but investors weren't buying it. The stock dropped 2.2%. So next, Coke dug into its bag of tricks and came up with the tried-and-true solution: A stock buyback. In addition to the $700 million remaining in its existing stock repurchase program, Coke announced Thursday it will buy back an additional 500 million shares.

This works out to $18.7 billion worth of stock -- or more than 11% of Coke's market cap at current market prices. You'd think investors might take this as a vote of confidence in the stock, and maybe start buying again. Problem is, Coke's last buyback program hasn't worked out well, with the stock lagging the rest of the S&P 500 by about four percentage points over the past year.

With Coke selling for nearly 20 times earnings today, long-term growth pegged at a mere 8%, and free cash flow lagging reported earnings by about 15% , the stock looks richly priced for limited potential. Long story short: It's still possible to find a bargain stock in this market, folks. But Coke isn't it.

CarMax (NYSE: KMX  )
In some ways, CarMax's planned buyback  is nearly as bad as Coke's. In other ways, it's worse. Last week, the nation's biggest used-car dealer announced it will spend $300 million buying back its own stock.

Now, in the company's defense, at least CarMax isn't running quite as an aggressive repurchase program as Coke is. The problem is that the $300 million CarMax does want to spend would use up most of the cash in its bank account, where the company has $458 million stashed ... but owes $5.4 billion in debt offsetting the cash.

Free cash flow is no help , either. If Coke's weak free cash flow means it's more expensive than it under GAAP, then CarMax is downright broke. The company hasn't produced a FCF-positive year since 2010. (Hasn't produced even positive operating cashflow, for that matter). Yet its stock, at 19 times earnings, looks nearly as expensive as Coke's.

My Take: CarMax should focus less on buybacks, and more on getting its business back on track.

AstraZeneca (NYSE: AZN  )
 Now I don't like to end this column on a down note, and fortunately, this week I don't have to -- because this week, I get to tell you about a company that's doing right by its shareholders -- eschewing PR-puffing buyback pronouncements and conserving cash for a rainy day.

Earlier this month, AstraZeneca became that rare thing in the equity markets: a company that admitted buybacks aren't always a great idea. On Oct. 1, AstraZeneca cut short its $4.5 billion buyback program, begun under a previous CEO, even though only half the shares authorized for repurchase had yet been bought back.

Why? After all, AstraZeneca has several billion dollars in the bank. Plenty to cover the rest of the buyback. But knowing that his company faces problems with expiring patents, and probably declining earnings, new CEO Pascal Soriot called canceling the buyback program "a prudent step that maintains flexibility while the Board and I complete the company's ongoing annual strategy update."

The bigger question, though, is that if AstraZeneca -- a stock selling for just 7.5 times earnings -- isn't convinced buybacks are a great idea at all times and in all environments, what business do Coke and CarMax have, buying back stock at 20 and 19 times earnings, respectively? And what does this imply for the buybacks that rivals Eli Lilly   (NYSE: LLY  ) and Bristol-Myers Squibb   (NYSE: BMY  ) announced back in June? Lilly shares cost 15 times earnings; Bristol-Myers, 16 times earnings.

Both stocks pay big dividends -- Lilly only a little bit less than AstraZeneca's 3.8%; Bristol-Myers a bit more. They face similar problems with the "patent cliff." What's more, analysts expect to see profits decline even faster at Lilly than at AstraZeneca. And while Bristol is expected to grow profits, its projected growth rate -- 1.2% -- is just a few basis points north of zilch.

Maybe all these companies should take a cue from AstraZeneca, and ask themselves: Are these buybacks rewarding our shareholders ... or just massaging our egos?

Buybacks have a habit of destroying shareholder value, even as they promise to preserve it. But when a company pays you a dividend, that's money in the bank. If you're looking for some great dividend stock ideas, let me invite you to read the Fool's brand-new special report "The 3 Dow Stocks Dividend Investors Need." It's absolutely free, so just click here and get your copy today.

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Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of AstraZeneca. Motley Fool newsletter services recommend Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (2)

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 October 22, 2012, at 3:45 AM, cozzawk wrote:

    Isn't AstraZeneca yielding 6.2%?

  • Report this Comment On October 22, 2012, at 10:39 AM, TMFDitty wrote:

    Free financial data sites' dividend numbers often get confused by foreign companies' dividends. S&P CapitalIQ, our primary source for this data, puts the dividend yield at 3.8%.

  • Report this Comment On October 22, 2012, at 3:16 PM, Guest912 wrote:

    I have access to S&P CapitalIQ and am still getting a dividend yield of 6.00%.

  • Report this Comment On October 22, 2012, at 3:31 PM, Guest912 wrote:

    The 3.8% quoted is a forward or projected yield, and has absolutely nothing to do with it being a foreign stock, but with the way they pay a higher dividend the first quarter and a lower one the third quarter. The projected yield is simply based on the most recent dividend (for AZN, currently the lower one of the year) projected over an entire year, hence a lower yield, because AZN pays a higher dividend the first quarter, and a lower one the third. (i.e. 8/12 dividend of .9 x 2= 1.8= 3.8% yield.) The flaw in this, is in February the higher dividend, (in 2/12 1.95) would create a very high projected yield. (1.95 x 2= 3.9= 8.3% at todays price) so you shouldn't be using the projected yield for AZN, but a trailing one, which is 6.00%.

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