Time was when a share-repurchase announcement meant one of two things. Either the company truly believed its share price was undervalued (signaling a time to buy for the rest of us), or the company was making a desperate attempt to prop up its share price (signaling a good time for shareholders to get out of Dodge).
Now it seems as though the majority of companies have some kind of share repurchase program. According to Standard & Poor's, share repurchases by S&P500 firms totaled $197 billion in 2004, up 51% from 2003. Despite that, S&P said those companies were still sitting on $619 billion in cash at the end of 2004, so don't look for the buyback momentum to slow anytime soon.
Now, I'm not opposed to this. Companies that have cash flow outstripping attractive investment opportunities need to manage that cash flow in a way that benefits shareholders. Investment bankers call this "capital structure management," and when you dig into the subject, it's hard to argue against share repurchase as an intelligent way to go. It's far more flexible than big dividend increases, which might not be sustainable if the company experiences a downturn. They also (at least in theory) should add to shareholder value through an acceleration of EPS, translating into higher share prices for the remaining stockholders. Finally, they don't have the tax consequences for shareholders that a dividend has.
But my interest these days as a value-seeker lies not in capital structure, a rather dry subject under the best of circumstances. I find it far more interesting to try to figure out what a share repurchase program can tell us about a company and its prospects as a solid future investment. A little research and some intuition can uncover a lot. Here are a few cases in point, some of which are pretty revealing.
I must admit that Costco
Speaking of buying shares back at a value price, I should note here the opinion of Warren Buffett of Berkshire Hathaway
What can we learn from this? I think that even in our current environment, clouded by the smokescreen of capital structure initiatives, there are signals to be found in the way companies decide to execute share repurchase activities. But it takes some research and more than a little intuition to dig them out. So much for the good old days, and happy hunting.
Tom Gardner also pays attention to share repurchases in Motley Fool Hidden Gems . If you enjoy small-cap investing, Hidden Gems might be for you. Consider a free, 30-day trial. There's no obligation to purchase.
For further enlightenment on share repurchase, check out:
- A raging bull, or just a cash cow?
- Try on a bit of shareholder chic.
- Don't think about getting in the way of this cash machine.
Fool contributor Timothy M. Otte could use some assistance with his personal capital structure. He welcomes comments on his articles and owns shares of Wal-Mart and Berkshire Hathaway.