Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
The Federal Reserve's monetary policy committee kicks off its two-day meeting today. Despite significant uncertainty regarding whether the Fed will decide to scale back its monthly bond purchases, stocks opened roughly unchanged this morning, with the S&P 500 down 0.17% and the narrower Dow Jones Industrial Average (DJINDICES: ^DJI ) up 0.05% at 10:12 a.m. EST.
The managements of large corporations appear to believe that share buybacks can only ever be an unmitigated good. They're (often) smart and conscientious people, but they're wrong on that point.
Last week, payment card processor MasterCard (NYSE: MA ) announced an 83% hike in its dividend and a new $3.5 billion share repurchase authorization. After yesterday's close, Dow component Boeing (NYSE: BA ) joined the party, announcing it would raise its dividend by half to $0.73 per share and add a $10 billion authorization to its existing share buyback program. In justifying the decision, Boeing CEO Jim McNerney said:
These actions reflect sustained, strong operational performance by our businesses, increasing cash flow, and our confidence in the future. Our team's relentless focus on business execution and competitiveness is providing the financial strength to continue investing in our core businesses while increasing our returns to shareholders.
Now compare that to a passage in Warren Buffett's 2011 Berkshire Hathaway shareholder letter:
Charlie [Munger, Berkshire's vice chairman] and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company's intrinsic business value, conservatively calculated.
McNerney alludes to the first of Buffett's conditions explicitly, but he appears to assume that the buybacks will increase shareholder returns -- certainly, there is no reference to the shares' intrinsic value. Meanwhile, the relationship between that value and the price paid is the only thing that determines whether a buyback adds or destroys shareholder value.
Take this year, for example, in which Boeing spent more than it had anticipated to repurchase shares. A year ago to this day, the airplane maker announced it expected to buy $1.5 billion-$2 billion worth of shares in 2013 with its previous authorization; the amount left on that authorization suggests the company bought $2.8 billion worth of shares instead.
Furthermore, Boeing's share repurchase activity appears to have accelerated as the stock price has risen (Boeing shares are up almost 80% year to date). In fact, the company bought no shares during the first quarter and it appears to have waited to make its largest purchases in the fourth quarter -- perhaps as much as $2 billion.
Unless one believes that the shares continue to sell "at a material discount to the company's intrinsic business value, conservatively calculated," that activity suggests a lack of discipline (or understanding) with regard to capital allocation. And, at Boeing's nearly 19 times next 12 months' earnings-per-share estimate, I think it's difficult to argue that Buffett's second condition is currently met.
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