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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: "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.
The mobile- and social-games maker just finished reporting third-quarter earnings featuring a $0.07-per-share GAAP loss. Hoping to mitigate the damage, management tossed investors a couple of bones. First, Zynga promised to lay off 5% of its workforce in an effort to save money. But then it said it would spend money buying back $200 million worth of stock.
I guess that pleased shareholders (although probably not employees), because the stock popped 12%. But here's the thing: Zynga has cash available for buybacks today, but maybe not for long. Though Zynga has historically been a reliable cash machine, generating positive free cash flow in each of 2008, 2009, 2010, and 2011, something bad happened to it this year. Its operating cash flow for the past 12 months is little more than what it generated back in 2010. But acquisitions costs are up by a factor of three, and capital spending has leaped sixfold.
Result: Zynga's now a net cash destroyer, burning nearly $250 million, if you count the cost of its acquisitions. Instead of spending what cash it's got left on buybacks, Zynga would be better off selling the company to someone who can run it better.
Management plans to repurchase 15 million shares, or about 12% of shares outstanding, for a total outlay of $62 million. With nearly $290 million in the bank, it's certainly got the cash to cover the cost today -- but it may be better off waiting to buy until tomorrow (figuratively speaking). In a recent sell note, Axiom Capital predicted solar inverter demand in key markets Germany and Italy will soon drop by 67% and 70%, respectively, damaging Power-One's sales in fourth-quarter 2012, and driving the company down to 44% factory utilization in 2013. That won't be good for profit margins.
Result: Wall Street wants Power-One to grow profits 38% next year. Axiom thinks its earnings will fall to $0.22 a share instead -- less than half the Street's estimate. If the analyst's right, and an earnings disappointment of this magnitude awaits us, Power-One might be better off keeping its powder dry a few months, when a big sell-off will enable it to buy back even more shares, at better prices. Investors should wait as well.
Gentex (Nasdaq: GNTX )
Now I don't like to end this column on a down note, and this week I don't have to -- because our third buyer-backer just beat earnings estimates, nearly beat revenue expectations, and followed up the good news with a 4-million-share repurchase announcement.
Despite a "deteriorating macroeconomic environment," and weak sales of automatic-dimming car mirrors in troubled Europe, Gentex said this year's fourth-quarter sales will basically track what it recorded last year, with only a "slight" decrease in gross margin. That's hardly devastating news, and with its stock selling for 44% cheaper than it used to, Gentex management thinks now's a great time to double down on itself. I think this is a fine plan.
At 14 times earnings, the stock doesn't look particularly expensive. Gentex's sales are holding up better than those at major customers Ford (NYSE: F ) and General Motors (NYSE: GM ) , which both just reported mid-single-digit declines. And Gentex's sales are projected to rise 13% over the course of the next five years. Fourteen times earnings seems a fair price to pay for that, and with the bonus of not having to pay a 3.1% dividend on the bought-back shares, this repurchase plan is a no-brainer.
Come to think of it, paying 14 times earnings for 13% growth, and getting a 3.1% dividend as a bonus, sounds like a pretty good idea for individual investors as well.
Gentex isn't the only great stock idea in automaking. Europe notwithstanding, Ford has been performing incredibly well as a company over the past few years -- it's making good vehicles, is consistently profitable, recently reinstated its dividend, and has done a remarkable job paying down its debt. But Ford's stock seems stuck in neutral. Does this create an incredible buying opportunity, or are there hidden risks with the stock that investors need to know about? To answer that, one of our top equity analysts has compiled a premium research report with in-depth analysis on whether Ford is a buy right now, and why. Simply click here to get instant access to this premium report.