3 Dow Stocks Hiding Weak Growth Prospects With Share Buybacks

These three Dow components have large buybacks, but that doesn't mean there's growth ahead

Matthew Frankel, CFP
Matthew Frankel, CFP, Sean Williams, and Dan Caplinger
May 26, 2015 at 7:15PM
Investment Planning

Don't be fooled by corporate smoke and mirrors. Photo: Flickr user Theilr.

Companies repurchase shares in order to return capital to investors, and this can help a company boost earnings. But there are some downsides to buybacks as well. Some companies' buyback programs boost earnings per share (EPS) to the point that the business appears to be growing more rapidly than it actually is. And every dollar used for share buybacks is one dollar that won't be invested in the future growth of the business.

Here are three Dow components our analysts think are implementing large buyback programs in order to mask their limited growth potential.

Dan Caplinger
One of the companies ultimate users of buybacks to boost earnings is IBM (NYSE:IBM). Since 2007, IBM has spent more than $10 billion repurchasing shares in every single year except 2009, when it spent "only" $7.4 billion. The result has been a massive drop in outstanding share counts from 1.38 billion shares in 2007 to just 985 million shares as of the most recent quarter.

IBM's buybacks have masked a huge slowdown in net income growth. Between 2008 and 2014, IBM's EPS jumped from $8.89 to $11.90, which equates to a slow but respectable growth rate of 34% during that six-year time span. Yet on an absolute basis, IBM's total net income dropped slightly from $12.3 billion to $12 billion. Other key financial figures, such as total revenue, have also declined substantially, showing the weakness in IBM's overall business.

One of the worst things about IBM's buybacks is that they've largely been made at much higher prices than today's share price. Recently, while the stock has fallen to its worst levels since 2010, IBM has essentially squandered money it could have used to pay dividends or invest in growth. Barring a successful turnaround, IBM could turn into yet another example of buybacks gone bad.

Sean Williams
Pharmaceutical giant Pfizer's (NYSE:PFE) top line has been clobbered since 2010 due to the loss of patent exclusivity on a number of key therapies. Cholesterol-fighting drug Lipitor, the best-selling drug of all time, lost its exclusivity, as did Detrol, Xalatan, and, most recently, Celebrex. During that period, Pfizer's full-year sales have dwindled from $67.8 billion in 2010 to an estimated $45 billion in 2015 (the midpoint of Pfizer's guidance).

Generally, the loss of a third of a company's revenue will send investors running for cover -- but not Pfizer shareholders.

Between dividends and share buybacks, Pfizer has returned close to $65 billion to shareholders between 2011 and 2014. In its recently reported first-quarter results, Pfizer announced that it has met its full-year commitment of $6 billion in share repurchases. This will be on top of an expected $7.2 billion in expected dividend payouts throughout fiscal 2015.

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While share repurchases (and dividends) have done their part to make Pfizer look a little better, its underlying business isn't as healthy as you'd think. Since delivering $14.6 billion in net income in 2012, Pfizer (excluding the one-time gain from its spinoff of animal health company Zoetis (NYSE:ZTS), watched its net income fall to $9.1 billion in 2014. Yet its EPS during that span has risen by 12% to $1.42 on a GAAP basis because there are nearly 1.1 billion fewer shares outstanding. These repurchases give the perception of growth, but they're really hiding Pfizer's weak apples-to-apples comparisons.

The future of Pfizer, at least right now, relies on a successful launch and labeling of advanced breast cancer drug Ibrance, as well as the potential spinoff or breakup of its innovative products and vaccine units from its global established pharmaceuticals business.

Shareholders likely don't have to worry too much about Pfizer, because it's a relatively non-volatile cash cow. But take note that without these buybacks, Pfizer would not be the growth company that its EPS growth makes it out to be.

Matt Frankel
Many investors simply don't realize just how big Intel's (NASDAQ:INTC) share buyback program is. During the fourth quarter of 2014, Intel's buyback was second only to Apple's (NASDAQ:AAPL) in terms of the dollar amount of shares purchased, and it was the fourth-largest for the entire year among all U.S. publicly traded companies.

Intel currently has a $20 billion buyback program, authorized last June, which is equivalent to 12.6% of the current market capitalization of the entire company. My problem with the massive buyback is pretty simple.

Although Intel has managed to deliver PC sales that have exceeded analysts' expectations in recent years, the industry is shifting toward mobile computing. While Intel is making some progress in its quest to enter the mobile space, there's still a long way to go. Put simply, I would rather see Intel take a good chunk of that $20 billion earmarked for buybacks and reinvest that money into growth efforts. Sure, shareholder returns may suffer in the short run, but that's Intel's best chance at adapting to industry trends.

I'm aware that Intel has more than $14 billion in cash and short-term investments on its balance sheet, and pretty low debt, so the company has plenty of cash in the bank to finance growth efforts. However, by reducing the buyback, Intel could get more aggressive with growth and innovation without dipping into its rainy-day fund and harming its balance sheet.