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 and 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 I? 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 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.

Church & Dwight (NYSE: CHD  )
Soap czar Church & Dwight delighted investors earlier this month when it reported Q3 earnings of $0.66 per share, topping estimates by a good 12%. Revenue, too, was up more than expected, and management added to the holiday-season cheer with a promise to spend up to $300 million buying back its own stock. There was, however, one small problem with that promise.

Church & Dwight doesn't actually have $300 million.

Oh, the company's probably good for the money. It's actually generating positive free cash flow of almost $350 million. But as far as cash in the bank goes, C&D only has about $240 million lying around, and even this is outweighed by its debt load of more than $900 million.

The bigger problem is that at nearly 23 times earnings, C&D's stock looks even more expensive than that of rival Procter & Gamble (NYSE: PG  ) . (Which only costs 19 times earnings -- and you already know what I think about that valuation). The fact is, with a growth rate that barely scratches 10%, C&D shares are pretty badly overvalued in their own right. They're certainly not a big enough bargain to justify spending $300 million on.

Universal Display (Nasdaq: PANL  )
Bad as the deal C&D shareholders are getting on their buyback may be, it pales in comparison to the money being blown on buybacks at Universal Display. After surprising shareholders with a Q3 loss earlier this month and suffering a prompt downgrade on Wall Street, the OLED tech specialist tried to stanch the bleeding last week with an announced $50 million buyback plan.

Terrible idea.

Unlike Church & Dwight, Universal Display has plenty of cash to fund a buyback -- nearly $240 million at last report. This historical money-burner is even generating a bit of free cash flow these days, so that's good news. The problem is that UD just isn't nearly cheap enough to justify buying back stock at today's prices. Shares costs more than 80 times annual free cash flow and a whopping 110 times earnings. So even if the company hits Wall Street's long-term growth target of 25%, it's hard to justify a buyback.

Plus, last time we checked, UD's growth rate was shrinking, rather than expanding. In this month's report, it cut 2012 revenue guidance from $100 million to as little as $80 million. If that's the best UD can do, it probably shouldn't be buying back shares at all.

SciClone Pharmaceuticals (Nasdaq: SCLN  )
I don't like to end this column on a down note. Fortunately, this week I don't have to. Earlier this month, SciClone Pharma disappointed investors with a small earnings miss, caused by weakened pricing of its flagship ZADAXIN hepatitis C drug in China. Adding to the worry, revenue guidance for the year tumbled 9%. Regardless, management bulled ahead with a $10 million addition to its buyback plan, which now stands at $16.2 million.

Weak near-term guidance notwithstanding, I see a lot to like in this plan. SciClone boasts a fortress-like balance sheet with $86 million cash and not a lick of debt. Uncommonly for a small biotech, it's throwing off loads of cash -- $65 million over the past year alone -- and is now in its third straight year of improving free cash flow.

Clearly, SciClone can afford this buyback. And with its stock trading for a reasonable 15 times earnings and an even cheaper four times annual free cash flow, I can't think of a better use of SciClone's cash than buying back its super-cheap shares.

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  • Report this Comment On November 23, 2012, at 4:26 PM, sidneyleejohnson wrote:

    The "terrible idea" is analysts not spending any significant amount of time understanding UDC revenue future and misleading investors (short and distort?) about the relationship between UDC revenue and the oem capex investment in new oled manufacturing production lines (nearly all SMD, but LG and others are scrambling to join soon).

    After 3 consecutive years of 100% growth in revenue, the 25% growth estimate has not budged... what a complete crock that statistic has been in the past and given the ongoing capex oled investment by SMD and others the CAGR in oled displays (and lighting) through 2019 is estimated to be way higher 25%. Companies don't get to rest on their laurels by blowing away this growth estimate year after year and then having one quarter of flat revenues before analysts and short sellers jump all over them by saying the growth rate is shrinking... the oled oem capacity growth is not linear by quarter. You have to look at the capex investments more broadly to see the trends and the trends going forward are still HUGE.

    To really do your homework, map Samsungs (SMD) oled capacity across time and across oled production lines like KDBDW's Will Cho does on his Duksan High Metal securites report every few weeks. In his report you can see how he tracks SMD's progress in their ramp up of various oled manufacturing lines A1 (4G), A2 (5.5 G) , A2E (5.5G), V1(8G), V2(8G) across time. Learn to appreciate the total oled volume each line produces in total and perhaps you would have noticed estimates of the quintupling of oled production by the end of 2014 . If you monitor these reports you can observe whether or not SMD is exceeding expectations or if whether there are any delays worth considering (total volume in 2 years down from earlier estimates of a 7x but still a substantial 5x). Perhaps being in Korea he is in better contact with SMD representatives to update this table/chart more frequently than peers in the USA who are either incapable of doing the same analysis or just plain lazy to lift a finger beyond their Bloombergs.

    Monitoring those changes in capacity trends (yes including the recent delay in expansion) one can get a much more clearer understanding of both what Robert Citrone @ Discovery Capital (the largest shareholder of panl) who bought at the low in the AH ~$20 after the Q3/EE disappointment and management sees coming when it decides that now is a good time for a buy more or buy back. I suggest everyone do similar homework and re-evaluate whether you think its important for forward looking investors to ignore the backward looking ratios you are so happy to share in favor actually trying to predict future revenue growth for UDC. Note Duksan High Metal was also hit by this delay in SMD oled expansion but Will Cho didn't steer away from his buy rating Duskan after a short term delay as the long term view of oled capacity growth is still significantly intact.

    You missed mentioning the introduction of flexible displays in 2013, green emitter and host material sales in 2013 as new oled lines allow for their introduction. Existing SMD lines are running at 100% capacity leading to no room to introduce the green material until new lines come online. Once green is online UDC material revenues more than double (they only sell red emitters) per "unit".

    You missed mentioning that the flat fees that tripled in 2012 (30m from 10m in 2011) are again expected to go up significantly(55-60M in 2013?). You ignore the emerging oled lighting market coming down the road. You ignore the fact UDC raised that cash (at a much higher price) specifically to buy patents/technology from Fuji in Japan, that they only used roughly 1/3 of what they raised and that they can't get a decent rate of return on that money sitting in cash and they can't hire enough phd's in oled chemistry fast enough to dent it...

    Given a huge pending ramp in oled production (5x by end of 2014 from SMD estimates without factoring in pending production from LG, AUO), more than doubling revenue per unit once lines are converted to use green emitter and host materials, increasing flat royalty fees every year (through 2017), and a stock down on negative news brought about by a mere delay in manufacturing growth the buy back and additional purchases by RC@DC aren't terrible ideas at all ...its a no brainer.

    thankfully UDC management wasn't limited by your distorted vantage point.

    Note also with >112% of UDC float owned by institutions its not likely many would care what your limited analysis concludes. The few shares owned by retail are owned by those with a much better understanding of UDC and its partnership with UDC... so I really don't even understand your target audience. Short Sellers?

  • Report this Comment On November 23, 2012, at 5:04 PM, sidneyleejohnson wrote:

    correction: 2 consecutive years of 100% revenue growth.. my apologies.

  • Report this Comment On November 23, 2012, at 6:18 PM, sidneyleejohnson wrote:

    another correction: "understanding of UDC and its partnership " with UDC should read "with SMD"

  • Report this Comment On November 25, 2012, at 6:46 PM, Blythe33 wrote:

    Mr. Smith's article about UDC neglected many things. I find it embarassing that it was listed under the Motley Fool masthead. Thank you Sidneyleejohnson for the long and in-depth comment. One thing that I did not see you note is that the shares were issued at over double today's prices. When the money from the share issuance was not all needed, the company decided to buy back some at a bargain to the issuance price.

  • Report this Comment On November 26, 2012, at 1:30 AM, sidneyleejohnson wrote:

    blythe actually i did mention it. Thanks.

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