Investors like buybacks because they reduce the number of shares outstanding, making each remaining share represent a bigger piece of the company. That, in turn, typically boosts earnings per share. Buybacks also instill confidence, suggesting that management believes the stock is currently underpriced. That makes sense with Hewlett-Packard, which has seen its shares fall about 20% in the wake of former CEO Mark Hurd's resignation.
The Wall Street Journal recently noted that buyback announcements often trigger jumps in share prices. Over time, companies that engage in buybacks tend to outperform the market by some 3 percentage points annually -- nothing to sneeze at.
The bad side of buybacks
Buybacks aren't always the best idea, though. Remember that companies could do other things with that money: building more factories, hiring more workers, buying more advertising, etc. A buyback is a reward, but it doesn't hold the promise of more growth.
Research and development (R&D) is critical for companies in many industries. As BusinessWeek magazine noted in 2009, "[B]uybacks are rampant in industries where investment in innovation is crucial -- energy, technology, and pharmaceuticals."
BusinessWeek detailed buybacks by ExxonMobil
In addition, many companies have timed their buybacks poorly. Intel
You want your bought-back shares to be attractively priced. That seems to be the case with Hewlett-Packard -- its recent P/E of around 11 is barely half its five-year average of 20, and its forward P/E is below 8, well below the S&P 500's 14.
Stock buybacks are a mixed bag. Hewlett-Packard's seems promising, especially since the company has a big cash pile and generates a lot more of those greenbacks annually. But in general, make sure the companies you like aren't wasting your money by paying too much to buy back their stock.
Buybacks may beat dividends on taxes, but hefty dividend payers are still darn compelling investments.
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Longtime Fool contributor Selena Maranjian owns shares of Amgen. Intel and Pfizer are Motley Fool Inside Value recommendations. The Fool has entered a bull call spread position on Cisco Systems. The Fool owns shares of and has written puts on Intel. Motley Fool Options has recommended buying calls on Intel. The Fool owns shares of Exxon Mobil. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.