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.
ARMOUR Residential REIT (NYSE:ARR)
On Dec. 17, ARMOUR admitted that 2013 will I all likelihood be its third straight year of lower dividend payments, announcing a monthly $0.08 dividend that amounts to just $0.96 a year -- down 37% from what it was paying as recently as 2010. To cushion the blow, management simultaneously announced a share repurchase program, promising to buy back up to $100 million worth of stock.
While I understand the motivation, though, I have to question the logic. I mean, sure, with more than more than $700 million in the bank, ARMOUR can certainly afford buying a few shares. But why? I mean, ever since it went public, ARMOUR has supplemented massive short-term borrowings with a flood of new share issuances. So why now turn around and buy back shares at -- what? $0.50 less than what it sold these shares for, initially? $0.25? Seriously, folks -- is this a real estate investor, or a day trader?
Remember: ARMOUR is supposed to use its cash to invest in residential mortgage-backed securities, and pay out dividends to shareholders. Every dollar spent on buybacks to support the stock price... is a dollar that goes uninvested in mortgages, and a dollar not paid out as dividends. And if those dividends continue to shrink, no amount of buybacks will be enough to save the stock.
General Motors (NYSE:GM)
Last month, GM made headlines with an announcement that promised to free it once and for all of the "Government Motors" moniker. The Treasury Department aims to unload its 500.1 million-share stake in the company, and GM's helping it along with a 200 million-share buyback.
Goldman Sachs loves the deal. I don't.
Why not? GM costs nearly 11 times "earnings" today, but it's generating so little cash that its price-to-free-cash-flow ratio is nearly three times as large -- 22.5. Its make-or-break Chevy Volt hybrid is gaining little traction in the market, continuing to lag Prius in popularity. And recently, Ford (NYSE:F) stole a march on GM with a 2,000-unit sale of its hybrid C-Max to General Electric (NYSE:GE). With a growth rate barely getting out of the gate at 11.6%, GM's share price looks likely to stall.
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, ZAGG, announced a small-scale plan to buy back $10 million worth of its stock -- and this is a deal I can get behind.
In case you're not familiar with the company, ZAGG's claim to fame is that it makes clever peripherals for the tablets and smartphones produced by a certain company whose name rhymes with "Snapple." It's a competitive market, and one with little moat to defend it. Still, at a valuation of less than 10 times profits, the stock does look attractive.
Analysts have ZAGG pegged for better-than-23% annualized profits growth over the next five years. The company just announced it will present more than 100 new products at this year's Consumer Electronics Show in Las Vegas -- everything from a new iPhone protector to wireless battery-chargers to new electronics toys for kids. It shouldn't take more than a few "hits" among that lineup to fulfill the Street's growth projections, and reward ZAGG amply for investing in its own stock today.
Investors today should beat the rush, and give ZAGG's stock a look before buyers get a gander at the new product lineup.
Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford and General Electric. Motley Fool newsletter services recommend Ford, General Motors, and Goldman Sachs. 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.