Your company's buying back stock? Hurray! Or should that be "boo"?
According to research conducted by Boston University finance professor Allen Michel, when a company announces it's buying back stock, that stock tends to outperform the market by about 2% to 4% more than it otherwise would have over the ensuing six months.
But over the long term, multiple studies argue that buybacks destroy shareholder value. As the Financial Times recently put it: "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 do buybacks at all? According to FT, management can use them to goose per-share earnings, which has an obvious benefit for company executives who get compensated based on earnings. In addition, the investment banks that organize and execute buybacks for management also get fees and other income from promoting buybacks. As for you and me, though, we miss out on gains unless those purchases cost less than the actual intrinsic value of the shares.
Meanwhile, here in the U.S., CNBC pundit Jim Cramer has blasted how big banks such as Bank of America bought back shares in 2007-2008 -- just before their stocks fell off a cliff. Cramer dismisses the concept of buybacks as buy signals, calling them "a false sign of health ... and often a waste of shareholders' money."
Unfortunately, several of the worst buyback offenders are at it again.
Two bad buybacks
Every weekday, the market sleuths at StreetInsider.com keep a running tally of which companies are buying back stock, and how much they're spending on the efforts. SI is too polite to accuse the companies of actually wasting shareholders' money, of course -- but I'm not. With SI's help, I've come up with two examples of popular stocks that I believe are squandering shareholder dollars on badly timed buybacks ... and one that isn't.
The first catcall this week goes out to travel-deals website Travelzoo. On Monday, the company responded to a 60% deep, four-month-long sell-off in its stock by announcing that it intends to repurchase 500,000 of those shares on the open market. Travelzoo certainly has the cash it needs to pull off the buyback -- but it shouldn't pull the trigger.
Unprofitable and selling for four times sales, Travelzoo shares look woefully overpriced. While it's true that peer websites like priceline.com
Speaking of money-losers. TiVo just reported a loss in its fiscal second quarter. The loss was smaller than expected, however, which sparked a 17% rally in the stock yesterday. Hoping to add fuel to the fire, TiVo followed its "earnings" news with an announcement that it's spending $100 million to buy back stock. Alas, its timing couldn't be worse.
Right now, TiVo's up-again, down-again earnings history makes the stock look as if it belongs to a profitable company. Don't be deceived. As early as next year, analysts expect TiVo to return to its money-losing ways. While it's certainly possible that the year after that, TiVo will be back in the black again, I wouldn't bet on it. Formerly a pioneer, TiVo's groundbreaking DVR business has already been commoditized by larger, better-funded rivals like Cisco
If TiVo's still got cash handy, it shouldn't be wasting it on buybacks. It should stockpile those greenbacks for the battle ahead.
A better use of cash
Speaking of better uses of cash, I don't want to end this column on a down note, and I did promise to tell you about one buyback program I actually like. That would be Lockheed Martin's
Lockheed sells for just 9 times earnings. It's also expected to grow more than 9.5% per year over the next half-decade. The company already pays a generous dividend of more than 4%. Best of all, its growth, dividend, and future as a business all look secure, since Lockheed will be building F-35 fighter jets for the Pentagon for decades to come. Unlike TiVo and Travelzoo, I think this stock's a steal.
Will TiVo and Travelzoo tumble? Will Lockheed Martin soar? Add all three stocks to your Fool Watchlist, and find out.
The Motley Fool owns shares of Bank of America, Lockheed Martin, Ctrip.com, and Google. The Fool owns shares of and has created a bull call spread position on Cisco. Motley Fool newsletter services have recommended buying shares of priceline.com, Google, Travelzoo, Ctrip.com, and Cisco.
Fool contributor Rich Smith owns shares of Google. 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.