Is the Dow's Buyback Frenzy Over?

McDonald's big buyback didn't boost shares. What's behind the shift?

May 28, 2014 at 9:05PM
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The Dow Jones Industrials (DJINDICES:^DJI) fell 42 points on Wednesday, with broad-based declines across many of the stocks in the Dow. But McDonald's (NYSE:MCD) was the biggest decliner on the day, despite the fact that it announced a huge return of capital to shareholders that ordinarily might have made investors optimistic about a company's prospects. Given McDonald's drop today, will ExxonMobil (NYSE:XOM), AT&T (NYSE:T), and other major Dow components with extensive buyback programs start pulling back on their repurchase activity?

Mcd
Source: McDonald's.

The McDonald's buyback and dividend plan was particularly generous to shareholders, with the fast-food company saying that it expects to return between $18 billion and $20 billion to investors through dividends and share buybacks during the next three years. With McDonald's sporting a market capitalization of almost exactly $100 billion, that capital return represents about a fifth of McDonald's total value.

Some of the consternation among McDonald's shareholders might come from the fact that the stock isn't priced nearly as cheaply as ExxonMobil, AT&T, and other companies that use buybacks routinely as a part of returning shareholder capital. Given McDonald's failure to produce extensive growth, trading at a trailing earnings multiple of 18 -- above the average for the Dow Jones Industrials as a whole -- shows the extent to which investors have already put a premium value on the fast-food giant's generous dividend yield. Further returns of capital aren't likely to make the stock any more attractive to income investors, and some worry that, by paying up for bought-back shares now, McDonald's could end up making a big capital-allocation mistake.

But more broadly, investors have to be somewhat concerned about the general trend among companies to buy back shares and return capital rather than reinvesting in their own businesses. With prevailing interest rates on cash of less than 1%, investors who don't need dividend income for current spending needs aren't thrilled to get big lump sums of cash back from their investments. Moreover, as the supply of attractive stocks gets smaller, buybacks threaten to distort market prices for those shares, and that further complicates the task of investors seeking smart investments both from the ranks of the Dow Jones Industrials, and elsewhere.

At least for now, though, McDonald's, ExxonMobil, AT&T, and other buyback-friendly members of the Dow aren't likely to change their ways. In all likelihood, it'll take a market downturn in order to dissuade companies from putting their spare cash toward reducing share counts and enjoying the resulting boost in earnings per share as a result.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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