Defying some experts' expectations, many U.S. companies have been buying back a lot of shares of their stock lately. And by "a lot," I mean almost twice as much as last year.
According to an AP story, the mutual fund research firm TrimTabs discovered that American firms are planning to buy back more than $170 billion worth of stock. "Companies have not been this eager to buy back stock since 1997, when $235.72 billion of repurchases were announced, according to data compiled by Dealogic."
Some experts are surprised because now that taxes on dividends have been reduced, there's less of an incentive for companies to use excess cash for buybacks than for paying dividends. (Read Mathew Emmert on how to protect your dividends from the IRS.)
One explanation is that companies are aiming to boost earnings per share (EPS) by reducing the number of shares outstanding. Here's how this works, in simplified terms: If a firm earns $100 in a period and has 100 shares outstanding, its EPS is $1.00. But if it buys back 25 of its shares and is left with 75 shares, and its total earnings are still $100, its new EPS would be $1.33. (One hundred divided by 75 is 1.33.)
Investors not paying close attention in the above example might be impressed by a 33% jump in EPS, when in actuality total earnings were flat, at $100. Still, the fewer shares a company has, the greater the value attributed to each remaining share. Buybacks do tend to benefit investors -- as long as the shares being bought back aren't overvalued. In that case, the company is squandering shareholder money and might as well pay it out in dividends.
The AP article noted that Cisco Systems (NASDAQ:CSCO) was a good example of an aggressive buyer, with plans to buy back up to $25 billion of stock. It also pointed out that as with many companies, Cisco uses buybacks to offset the effects of dilution caused by stock options.
Learn more about buybacks in these articles:
- Dell's (NASDAQ:DELL) Hollow Buybacks
- Buybacks: The Invisible Yield
- The Power of Buybacks
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Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.
