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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 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.

Procter & Gamble (NYSE: PG  )
Procter & Gamble surprised a lot of investors last week -- and pleasantly -- when instead of reporting the $1.11 a share in fiscal-second-quarter profit it had been expected to produce, the company announced it actually earned $1.22. P&G shares promptly popped 4% in response to the news. Sadly, what should surprise exactly no one is that now that the stock costs more, management has decided to buy more of it, saying it now plans to buy back at least $5 billion of its shares.

That's a bad decision, and I'll tell you why.

Priced at 15.5 times earnings, P&G certainly looks cheap enough, but looks can be deceiving: 15.5 times earnings is actually a bit expensive, considering that few analysts expect the company to grow its profits any faster than 8% a year over the next five years. It's also a deceptively low-looking number for two reasons: First, it doesn't take into account P&G's $26.5 billion net-debt load. (If that were counted as part of its market cap, we'd be saying P&G has a P/E of 17.7.) Second, it doesn't mention that with just $10.7 billion in free cash flow backing up its earnings, P&G actually only generates about $0.83 in real cash profit for every $1 it says it's "earning."

Nokia (NYSE: NOK  )
Then again, at least Procter & Gamble has free cash flow. Because our other featured cash-profligate today -- Nokia -- does not.

Oh, sure. I know I gave Nokia props last week for finally turning in an FCF-positive fourth quarter. I even expressed some hope that the company is turning itself around. Remember, though, that this is for now just a hope. And remember, too, that one FCF-positive quarter doesn't change the fact that Nokia burned cash the other three quarters of last year, and ended the year nearly $1.1 billion in the red for cash-burn. Regardless, the company promised to make all that right, and spend more than a billion dollars buying back as many as 370 million Nokia shares over the next 18 months. Of course, to find the cash to do this, Nokia had to suspend its popular dividend program.

My reaction: Thanks, but no thanks, Nokia. If it's all the same to you, I'd rather take the cash. Then, if the numbers look right, I can buy back your shares myself.

Herbalife (NYSE: HLF  )
Come to think of it, though, if Nokia could be persuaded to reinstate its dividend, I might actually be tempted to spend the money on another stock entirely. You see, I don't like to end this column on a down note, and fortunately, this week I don't have to. Because as it turns out, one company that's buying back shares today -- Herbalife -- actually looks like quite a good bargain.

Priced at a lowly 11.3 times earnings, but growing these earnings at upward of 15% a year (and not for nothing, paying a 2.8% dividend yield to boot), Herbalife shares look awfully tempting at today's prices.

Is the stock controversial? Is it "risky?" Sure it is. That's why hedge fund honcho Bill Ackman is shorting Herbalife. But if you ask me, the $427 million in real free cash flow this company generated over the past year is proof positive that Herbalife is for real, and its profits reliable. Unless and until that changes, I think Herbalife's entirely right to be buying back shares -- as it recently promised to do.

Unless you think the company is bald-faced lying about its cash flows, you might want to pick up a few shares, too.

More expert advice from The Motley Fool
Nokia's been struggling in a world of Apple and Android smartphone dominance. However, the company has banked its future on its next generation of Windows smartphones. Motley Fool analyst Charly Travers has created a new premium report that digs into both the opportunities and risks facing Nokia to help investors decide if the company is a buy or sell. To get started, simply click here now.

Read/Post Comments (5) | 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 January 28, 2013, at 1:26 PM, robmxa wrote:

    I like the way that Nokia is using my dividend to either buy shares or build Lumias. Very happy camper. They could use it all to build Lumia 620's.

  • Report this Comment On January 28, 2013, at 1:36 PM, mkj152us wrote:

    uh oh nokia is going up...time for FOOLS to predictable.

  • Report this Comment On January 28, 2013, at 1:39 PM, Berstein wrote:

    When now Dows and S&P have hit all time highs, there are barely any cheap stocks than Nokia.

    Nokia which has come down 90% from its highest is a stock to consider,

    because it is extremely cheap and the reward can be one of the biggest in NYSE for the future.

    Nokia is a stock with great upside opportunity and why:

    1) Nokia´s bankruptcy is already remote.

    Nokia has increased net cash to about $5.7 billion.

    Nokia´s worst loss has been $290 million a quarter in 2012.

    Even with this kind of loss, Nokia could still deal by its own net cash for at least 4 years!

    2) Nokia won´t have to deal with that kind of loss in the future and why

    A. Nokia has cut cost expenses. The layoff in 2012 starts to be fully effective in 2013.

    B. Now Nokia has to pay royalty to Microsoft, but Nokia has patent incomes.

    C. Nokia has managed to make the important tough work for the basis of its new platform WP.

    Nokia has already sold over 15 million Lumia phones up to date (9.9 million units from Lumia debut till the end of September 2012 + 4.4 million units in the last quarter of 2012 + January 2013).

    D. Nokia has now a high end phone that can make “halo effects” and be compared to Apple´s and Samsung´s most high-end phone, the Lumia 920.

    The demand of this phone is still high in many countries around the world. The 4Q12´s Lumia sales did not include the sales of Lumia 920 in many countries, such as India, Asia-Pacific, UAE, Latin America, and many other countries around the world yet, because the phone was arriving these countries only starting from January 2013.

    Even in Europe, many countries start to get this phone starting 1Q13, for example the Netherlands announced the phone arriving in January.

    And China Mobile received only first lot of Lumias 920T around Christmas, the second and third lot and further have arrived China, and the phone is still selling out.

    E. China Mobile deal. When now, both China Mobile and China Unicom are subsidizing the Lumia 920 heavily, the 2-year or 3-year contract is starting from

    0 or 1 yuan, and considering only less than 1/5 of Chinese people are using highest-end smartphones,

    this will result into a huge number of 2-year or 3-year contract users for Nokia in China! Besides, 3G penetration in China is still very low, there is a huge opportunity there. Additionally, among the highest end phones, Nokia Lumia 920 is significantly much cheaper than for example iPhone 5 and Galaxy Note II. Nokia has an advantage in both the price competition and the biggest carriers´ backing in China!

    F. Nokia Siemens Networks (NSN). During these few months NSN has won many 3G and 4G contracts in many countries.

    According to NSN, they have network equipment that can boost the speed of 4G many times faster. This shows that, beside PureView camera technology, HD+ sensitive screen technology, advanced mapping platform HERE and City Lens, Nokia has also top innovations in building 4G LTE networks.

    G. MWC is coming soon. There are still more to come from Nokia.

    According to The Verge, Nokia will launch Lumia Eos (PureView camera phone), Lumia Catwalk (international flagship phone) and Lumia Laser (Verizon flagship phone).

    According to CEO Stephen Elop, Nokia is also planning a lot of interesting things with Verizon.

    Nokia is likely launching tablet as well, even with some loyal fans of Nokia around the world buying some of Nokia´s tablets, this will be a good gain for Nokia.

    Nokia will launch more Lumia phones in the coming months to attract different consumer demands. More lower price-point,

    mid-range and high-end WP8 Lumias are to come.

    In 1Q13, beside Lumia 920 and Lumia 820 which are making their way to more markets and with better supplies, Nokia is also attracting the mass markets with budget WP phones Lumia 620 and Lumia 505.

    F. Asha phones. Asha phones are now selling almost 10 million units a quarter.

    Asha phones are affordable and competitive. Asha phones have now more and more smartphone features.

    Apart from features like Facebook, Twitter etc. Asha phones

    have internet access and access to thousands of Nokia´s most popular apps.

    Nokia has also brought an app called “Nearby” into Asha phones. Nearby is almost the same as City Lens in Lumia phones which is exclusive and unique in mapping and location data.

    There is still plenty of room for Asha phones to grow, because the price is competitive (cheapest android is right now about $100, while Asha is only about $70 without any contract).

    Apart from the features and price mentioned above, there are important and good selling points in Asha phones against cheapest androids, for example 40 free most popular games!

    Asha phones are still profitable for Nokia, because the OS is from Nokia itself, Nokia does not have to pay royalty for it.

    3) While bankruptcy is remote, Nokia´s stock price is still heavily undervalued.

    NYSE tech stocks are usually 2x book value, Nokia is still way much below that.

    According to Morningstar´s valuation, the sum of parts of Nokia (NSN, Navteq, feature phones, smartphones and patent portfolio)

    is worth much more than Nokia´s stock price right now, not to mention Nokia´s $5.7 billion net cash added to that value!

    Two years ago NOK was still about $15, now the stock is only over $4, the reason is that the stock has been over sold.

    Nokia is the most short sold stock in both Helsinki and New York! The shorts are still over 20% in Nokia´s total share number which is approximately 3.75 billion shares.

    This is a huge number, considering Apple´s short interest is only around 1% and Samsung´s around 2%. When Nokia is here to stay, the shorts need to be covered and the stock will skyrocket from these levels.

    Nokia Apple Intel Microsoft Cirrus Logic

    0.32 3.0 2 3.0 3.76

    Note that Nokia is currently selling at 0.32 price/sales ratio. This means that if the company manages to restructure and return to normal profitability, the stock has the potential to become a 10x bagger (even from today’s price levels) – assuming the market will value Nokia 3.0x sales like Apple or Microsoft. But even a price/sales ratio of 2, like Intel has, means a 6x bagger from these levels.

  • Report this Comment On January 28, 2013, at 1:49 PM, mkj152us wrote:

    you should write for the fool, writing, and using pertinent information!......nahh why start now.

  • Report this Comment On January 28, 2013, at 2:44 PM, Jjmc2001 wrote:

    The author is woefully misinformed. NOK has had a long-standing stock buyback program suthorized by the Board and renewed annually as part of their annual meeting. Mr Elop has said several times over the last year that they have no intention of doing so. Researchj is your friend. Unfortunately now Cramer is quoting this article. Obvious he does not do his own research either.

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