Your company's buying back stock? Hurray! Or should that be "Boo!"?
According to Boston University finance professor Allen Michel, when a company announces it's buying back stock, that stock tends to outperform the market by 2% to 4% more than it otherwise would have over the ensuing six months.
But over the long term, multiple studies show that buybacks actually destroy shareholder value. CNBC pundit Jim Cramer cites the example of big banks that bought back shares in 2007-2008 -- just before their stocks fell off a cliff. Far from buy signals, Cramer calls buybacks "a false sign of health ... and often a waste of shareholders' money." Indeed, the Financial Times recently warned: "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 run buybacks at all? According to FT, management can use them to goose per-share earnings, which helps CEOs earn bonuses based on "performance." Also, the investment banks that run buybacks earn income and fees from promoting them. But you and me? Unless the purchase price is less than the shares' intrinsic value, we miss out.
And we're about to miss out again.
Two bad buybacks
StreetInsider.com keeps a tally of which companies are buying back stock and how much they're spending. SI is too polite to accuse companies of wasting shareholders' money, of course -- but I'm not. With SI's help, I've uncovered two examples of popular stocks that I believe are squandering shareholder dollars on ill-timed buybacks ... and one stock that isn't.
Skyworks Solutions (NASDAQ:SWKS)
First up, mobile communications chip maker Skyworks Solutions translated improving sales into deteriorating profits in last month's quarterly earnings report. It wasn't alone -- rivals RF Micro Devices (NASDAQ:RFMD) and TriQuint Semiconductor (NASDAQ:TQNT) delivered numbers that were even worse than Skyworks'. Even so, when combined with weak guidance, Skyworks set itself up for a sell-off, and that's just what it got -- shares down 17% in a day post-earnings.
But management went right to work on damage control, announcing a plan to buying back $200 million worth of its now-cheaper shares. The problem: The shares still aren't cheap enough.
Priced at more than 21 times earnings, and with weak free cash flow that gives it an even higher P/FCF ratio, Skyworks' shares cost about one-third more than their 15.6% long-term growth rate would appear to justify. While it's healthier than its rivals, Skyworks isn't yet worth buying itself.
One thing I'll say in defense of Starbucks' Nov. 15 decision to buy back 25 million shares: With the shares now fetching 29 times earnings, at least they're not as grossly overpriced as the more than 36 P/E ratio that Starbucks is paying for Teavana. But even at 29 times earnings, Starbucks is no bargain.
The company's only growing its profits at 18% per year, per analyst estimates. Worse, with Starbucks generating less than $0.65 in real free cash flow for every $1 it claims to be "earning" under GAAP, the stock's arguably even more overpriced than it already looks.
Honestly, if Starbucks' $1.5 billion in net cash is burning a hole in its pocket, maybe management would be better advised to take a cue from Costco (NASDAQ:COST) -- and pay it out quick in a special, pre-fiscal cliff dividend -- than fritter it away on overpriced share repurchases.
Now, I don't like to end this column on a down note, and fortunately, this week I don't have to. A few weeks ago, haute couture handbag-maker Coach followed up on a strong third-quarter earnings report with even more good news for shareholders: It's taking $1.5 billion out of its corporate purse, and spending the money on share buybacks.
Not all at once, of course. After all, Coach only has $760 million in the bank right now. But with nearly $1 billion in annual free cash flow, Coach should have ample cash to deploy over the three years the buyback is to remain in effect.
Those three years should also give Coach time to pick and choose its purchases. Don't get me wrong -- currently priced at 16.2 times earnings, Coach shares already look like a fair deal based on the company's projected 13.7% growth rate and 2.3% dividend yield. With the shares down 27% from their 52-week high, there's nothing wrong with doing a little "nibbling" at today's levels. But Coach should still try to pace itself, and "buy on the dips," if it wants to get the most for its money.
Meanwhile, individual investors can feel comfortable dollar-cost-averaging right alongside management.
Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of Coach, Costco Wholesale, Starbucks, and TriQuint Semiconductor and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Coach, Costco Wholesale, and Starbucks. 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.