Investors are constantly in search of indicators that signal an undervalued share price, and thus the right time to buy. A common metric many analysts use is the announcement of a large share repurchase.
But all too often we find that management is no better at timing the market than ordinary investors. In fact, sometimes it can be much worse. On the surface, this doesn't seem to make any sense. Management is privy to a whole host of inside information that investors can't see. Shouldn't managers know what their stock is worth?
Theory says yes, but practical application yields a resounding no. Investors can no longer look to share repurchase announcements on their own as a valid signal. They have to dig deeper to understand the reason -- then make their own judgement on whether the shares are worth owning at today's price.
Here's three recent cases to illustrate the point. I call them the good, the bad, and the ugly.
| Shares Purchased in the First 3 Months of Fiscal 2007 |
Dollars |
Shares |
Avg. Price |
*Premium |
|---|---|---|---|---|
|
AutoZone |
$464.5 |
3.8 |
$123 |
5% |
|
Sears Holdings |
$2,400 |
16.4 |
$145 |
50% |
|
Home Depot |
$10,700 |
289 |
$37 |
37% |
Source: Third quarter 2007 press releases. All numbers in millions, except share price.
*Premium based on average price paid compared to closing price on 3/3/2008.
The good
Autozone's historical repurchasing pattern is about as predictable as the phases of the moon. For years, it has been spending roughly all of its annual free cash flow to retire shares.
In this case, I doubt management intends to signal anything to investors. The company operates in a business segment, retail auto parts, that is largely saturated. Management has decided it's the market leader in a slow-growth business, and it uses share repurchases to goose single-digit net earnings growth into double-digit EPS growth.
While the debate continues to rage over whether share repurchases are a better deal for investors compared to dividends, Autozone's buyback strategy evidently is working, as its return on equity outpaces the industry average by a long shot.
The bad
Sears Holdings invested $2.4 billion in buybacks during the first nine months of 2007, shelling out a whopping 50% premium over the current stock price along the way.
Talk about bad timing. Chairman Edward Lampert addresses this very issue in his annual letter to shareholders: "Although we believe it was a prudent use of cash, it would have been better if we had exercised more patience in the buyback as our share price continued to decline as the year progresses."
But it looks to me more like misplaced judgement than bad timing. Sears is woefully behind competitors like Target
I hear Mr. Lampert's argument that capital investments haven't paid off too well the past few years, but blowing about $800 million from the buyback plan doesn't strike me as overly prudent. Putting those dollars back into the business would have likely produced a much more successful return on investment. In this case, even sitting on the pile of cash seems like it would have been a more sensible idea.
The ugly
And speaking of bad timing, I feel for Home Depot, I really do -- this was truly a case of ugly timing. The company sold its supply business, generating $10.3 billion, and decided to give the money back to shareholders through a Dutch auction share repurchase.
The company displayed some foresight when it lowered the auction price range by $2 a share in mid-stream, seeing the stock price sliding south. But in the end, it still overpaid by a handy $3.2 billion. Oops.
That's a handful of shareholder value to waste. True, the intention was appropriate -- get a windfall of cash and return it to shareholders. But, in this situation, the execution was flawed.
A Foolish lesson
The takeaway from this is that high-powered corporate executives are no better at timing the market than the rest of us Fools. While share buybacks can trigger interest in purchasing shares, investors must follow with their own due diligence to decide whether a company buying back its shares looks like a good move, a bad decision, or a truly ugly disaster waiting to happen.
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