Is Hewlett-Packard Crazy?

Many companies use stock buybacks to boost share prices and get rid of excess cash. But buybacks don't always work out well for companies or their shareholders.

Hewlett-Packard (NYSE:HPQ) recently announced that its future is looking brighter and it's tripling its planned share repurchases, upping the limit to $12 billion worth of stock. To put that in perspective, the company's market capitalization was recently around $117 billion, so the buyback would be tackling roughly 10% of the company's value.

As you've probably learned before in Fooldom, stock buybacks can be terrific for shareholders, but they can also be misguided and damaging. The key issue to consider is the price at which a company is buying back its shares, since the money its using is money that could also be deployed in other ways. Think, for example of the Home Surgery Kits (ticker: OUCHH) company. Let's say you're a shareholder, the stock is trading around $50 per share, and you think it's gotten ahead of itself a little, and is really worth just $40 per share. Would you go out and buy more shares of the company now? No -- because it seems overvalued and you'd sensibly rather invest your money in more compelling places.

But if the company's management decides to buy back $50 shares, it's doing so with shareholder money and is destroying value. It would do better to just pay the money out to shareholders as a dividend, and let them invest it elsewhere. Or maybe it could use the money to pay down debt or invest in a value-creating project. Share buybacks need to make sense.

Assessing value
So let's return now to Hewlett-Packard and its ambitious buyback plans. Is it buying at reasonable or inflated levels? Well, you can find historical price and valuation data online at various websites. For example, in our Motley Fool CAPS community of investors, I noticed that the company's financials look promising, with return on investment and margins a little above their five-year average levels. In addition, Hewlett-Packard's valuations looks reasonable, with its current P/E ratio of around 16 below where it's been for most of the past decade, and its price-to-cash-flow ratio below average, as well.

All together, these suggest that the stock is at least somewhat undervalued, so buying back shares may not be a mistake. Interestingly, though, the stock has earned only three of five stars in CAPS, suggesting that there are a fair number of bearish views on the company, as well. (You can read extensive commentaries on this and thousands of other stocks in CAPS.)

Looking elsewhere
If you're interested in other companies with major or increased buybacks planned, check out the following: 

Source: Company releases. Based on prices as of Nov. 30. *Amounts include only most recent authorizations and in some cases exclude outstanding but previously authorized buyback amounts.

When looking at any company that's buying back shares, be sure to assess whether their buybacks make sense -- this is a good way to get a handle on management's sensibility. Consider Netflix (NASDAQ:NFLX), for example. My colleague Jim Mueller took issue with them recently, noting that the company bought back many shares when they were around $30 apiece, but it has recently been buying back shares when they were near $50. Clearly, the later buybacks must represent less of a bargain.

In general, investors tend to view stock buybacks positively, assuming that they mean a company's management is bullish about the company's future. That can be a faulty assumption, though -- so before you get excited about a buyback announcement, consider whether the company is spending its money (which is really shareholder money) effectively. If you think there are better ways for a company to spend its money, such as perhaps buying a competitor or a company with complementary technology, then you might find a buyback to be not-so-great news. 

More Foolish thoughts on buybacks:

• Your Company Did a Terrible Thing
• When Companies Buy High and Sell Low
• Bad Buyback, Bad!