Reassessing Jim
In general, I think people give Jim Cramer too hard a time. Sure, he talks too much, and when you give opinions on as many stocks as he does, you're bound to be wrong as often as you're right. But he's entertaining, and from time to time, he says some pretty smart things.
Tuesday was not one of those times.
In a riff on share buybacks, Cramer complained that companies like Coca-Cola (NYSE:KO) and General Electric (NYSE:GE) that buy back repeatedly -- "textbook buybacks," as Cramer calls them -- "have not successfully moved their stocks through the practice."
Come again?
"Have not successfully moved their stocks?"
Since when is "moving" the stock a good reason for doing anything?
Have these overheated markets cooked everyone's brains? Has everyone forgotten the ultimate goal of all that great bookkeeping at Enron, WorldCom, and cautionary mea culpa du jourFannie Mae (NYSE:FNM)?
Back to basics
The point of a buyback is not to "move" the stock -- not over the short term. The point of a buyback is to increase shareholder value in the long run by giving existing shareholders a bigger cut of future economic benefits. Quite simply, if a stock is cheap enough that buying back shares presents the company with a better opportunity to reward shareholders than would capital improvements, growth initiatives, acquisitions, or simply collecting interest at the bank or with T-bills, then a buyback is good. Companies with strong and consistent returns on capital -- like Anheuser-Busch (NYSE:BUD) -- can make good arguments in favor of borrowing at low rates to fund these buybacks.
Smart investors shouldn't care one whit whether this means a discernable move in the stock. In fact, smart investors should prefer that the stock not move in the short term, or even that it take a dip. That would give them a chance to buy more of a good thing while it's still cheap. After all, if the buyback makes sense economically, the rewards will come through increased shareholder value down the road, and the stock price will take care of itself.
But when a buyback is made for other reasons, watch out.
Bad buybacks
In fact, there are bad buybacks out there, and you investors should give them the courtesy and respect due that family of rats that winters in your shed, munching on your hard-earned birdseed.
The most obvious of these are those buybacks that serve only to soak up massive dilution created by options handouts. The buybacks at options-happy tech highfliers are a prime example. The recent Amazon.com (NASDAQ:AMZN) repurchases haven't stemmed the tide of dilution unleashed years back. The share count at eBay (NASDAQ:EBAY) has continued to balloon, despite the fact that the company has thrown more than $660 million at a repurchase program through three quarters of this year.
But there's another flavor of buyback out there these days -- the smokescreen.
Coattails
Here's what I see happening: Buybacks get a lot of news these days. They seem to have become more prevalent among blue-chip companies, which are pretty flush with cash and still have access to pools of cheap, borrowed capital. Buybacks are in the news a lot, and because, done right, they can increase shareholder value, they're seen as an emblem of good corporate governance.
But the badge of honor doesn't wear well on every management team. I see more and more struggling companies taking the buyback road, without much regard for whether the buyback actually makes sense. Many of these buybacks are, in my opinion, designed only to move the stock, and nothing more. (Jeff Matthews' blog has a long but funny tale of one such recent buyback here.)
I'm even seeing more and more hopeless penny stocks give this technique a try, with the buybacks accompanied by lavish PR, of course.
Let me be blunt: This is exactly the kind of share-buying company you should avoid. At all costs.
Bad buyback, bad management?
Managers who make decisions on how to deploy your money based on what they think it will do to the stock's short-term price are not to be trusted. At best, they will be wasting dough better spent elsewhere. At worst, you're seeing signs of desperate -- but perfectly legal -- market manipulation. Do you really want to wait around and see what kind of tricks these folks will come up with next to "move the stock?"
The bottom line is simple, Fool. Avoid bad buybacks, and whatever comes next, by investing with managers who make their decisions based on long-term increases in shareholder value. They may be few, and they may be hard to find, but they are out there.
If you're looking for companies priced so low that buybacks make sense, take a ride on the cheap side with Motley Fool Inside Value . A free guest pass is available.
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At the time of publication, Seth Jayson had no positions in any company mentioned here. View his stock holdings and Fool profile here. Fannie Mae, Anheuser-Busch and Coca-Cola are Motley Fool Inside Value recommendations. Amazon and eBay are Stock Advisor picks. Fool rules are here.
