A company's stock buyback could be a sound tactic or an effort to manipulate prices. How can investors tell?
By SCOTT BARANCIK
Published May 25, 2003
Parents will do almost anything to get a baby to eat his strained peas.
They'll coo about their yumminess. They'll inch the spoon toward him while making choo-choo noises.
When all else fails, they'll take a bite themselves, bug out their eyes and rub their tummies with feigned joy. The message: This stuff is so darned good, even I can't resist it.
So it is with stock buybacks. In 2001 and 2002, Fortune 500 companies announced plans to repurchase up to $300-billion of their own stock, according to Thomson Financial. Many smaller firms followed suit.
Their explanations to investors were pure strained peas.
"Our stock is underpriced," a hypothetical chief executive says in a typical news release. "In fact, we can find no better use for our excess cash than to repurchase some of the shares we once sold to you, dear investor. If you hold onto your existing shares - or better yet, buy more - their value just might rise (wink, wink)."
This year is no different. Companies including Checkers Drive-In Restaurants of Tampa, Lincare Holdings of Clearwater and Z-Tel Technologies of Tampa are trumpeting new buyback plans. Others, including Walter Industries of Tampa, Catalina Marketing of St. Petersburg and Maritrans of Tampa, are repurchasing their stock under existing programs.
All of them are hoping you'll be inspired to take a bite, too. Should you?
An emerging body of research suggests that, on average, buybacks boost a company's stock price, and not just on the day they're announced. A soon-to-be-published study by researchers from Taiwan, Korea and the University of Illinois found that companies that announced buybacks between 1980 and 1996 outperformed their peers by an average of 6.7 percent after one year, and 23.6 percent after four years.
The results so impressed one of the researchers that he says he is trying to "parlay it into an investment vehicle." David Ikenberry, chairman of the finance department at the University of Illinois at Urbana-Champaign, is working with Freeman Associates Investment Management of Rancho Sante Fe, Calif., to create a managed portfolio of about 100 buyback stocks for pension fund clients.
Another believer is David Fried, editor and publisher of the Buyback Letter. His monthly newsletter offers subscribers model stock portfolios based on buyback-related research and promises "stellar returns."
Fried's various portfolios have produced an average annualized return of 13.2 percent from the concept's inception in 1997 through the end of April, newsletter watchdog Mark Hulbert says. By comparison, the Wilshire 5000 index produced annualized returns of 4.5 percent.
But what about the investor who owns, say, 500 shares of troubled Z-Tel Technologies and wants to know if that company's recent buyback announcement is a positive sign?
And what about doubters like Cory Walker, chief financial officer at Brown & Brown? Walker says the Tampa insurance brokerage repurchases just enough stock to keep its employee stock plans from diluting earnings. He dismisses anything more as empty calories and a poor use of cash. Other critics question the true motivations behind buybacks.
But Ikenberry and Fried say the average investor can assess the likely impact of a company's buyback plan, provided they know a few tricks.
Federal regulators seem to have mixed feelings about stock buybacks.
When times are troubled and investors wary, buybacks can help save stock prices from crashing. That's why the Securities and Exchange Commission temporarily relaxed buyback rules after the Sept. 11 terrorist attacks. Corporate America's enthusiastic response helped smooth out the imbalance between buyers and sellers.
If left unregulated, however, some companies might use buybacks to manipulate stock prices. A cleverly timed trade, for example, could help a company lower the cost of a stock-based acquisition, or boost a CEO's profit on the sale of stock options.
Such scenarios inspired buyback rules the SEC introduced in 1982. Rather than stem the flow of buybacks, the new rules opened the floodgates. Companies once fearful of lawsuits over allegedly predatory pricing could now repurchase their stock with confidence.
The rules haven't made buybacks easier to track, however. After a company announces it "intends to repurchase as many as XXXX shares," there's no rule requiring it to say when and even whether it actually did so. And few buyback announcements reveal the often complex motivations behind them.
When office equipment distributor Global Imaging Systems unveiled a $10-million buyback plan in 2000, the Tampa company called its stock an "attractive investment" and said its board of directors felt it was "prudent and timely to support our loyal shareholders." A second buyback plan was introduced in 2001.
As usual, though, there was more to the story. At the time, chief executive Tom Johnson said in a recent interview, Global officials wanted to keep the stock price from being tarnished by competitors such as Xerox Corp., whose troubles appeared to be souring investors on the entire category.
There were other reasons. Global could redeploy the cheap shares it purchased in a future acquisition, lowering its cost. And if the buyback pushed Global's stock price up, the company could issue new shares and use the proceeds to pay down debt. It did precisely that in 2002, a move that boosted its credit rating.
"It was the right thing to do," Johnson says.
When Z-Tel Technologies' announced its first-ever buyback plan in March, CEO Gregg Smith said the program "reflects our belief that the current per share market price of our common stock does not reflect the Company's growth prospects."
Perhaps so. But an unspoken goal of the 1-million-share plan, investor relations director Sarah Bialk confirms, was to boost the Tampa phone company's share price above $1. Doing so convinced the Nasdaq SmallCap Market not to "delist" its stock for failing to meet its standards for inclusion.
Companies also use buybacks to supplant dividends, replenish employee stock options and pension funds, discourage hostile takeovers and balance their capital structure, researchers say.
Not everyone is enamored of buybacks.
During a March conference call hosted by Checkers Drive-In Restaurants, one participant urged the Tampa burger chain to abandon its buyback plan and pay down debt instead. He also questioned the fairness of doling out the company's hard-earned cash to investors who want to sell out. Shareholders who want to hold onto their stock get no direct benefit.
Cory Walker, the Brown & Brown CFO, says stock buybacks aimed at boosting share price signal that a company is out of ideas. Healthy businesses should spend their excess cash on dividends, new hires, product development or acquisitions, not buybacks.
"Philosophically," he says, "we feel it's like eating your children."
How can the average investor tell whether a company's buyback plan will cause its stock price to flourish?
Though there are no foolproof tests, a draft paper by Ikenberry, Konan Chan and Inmoo Lee, titled Economic Sources of Gain in Stock Repurchases, reveals several statistical patterns among companies that announce buybacks:
Small-cap companies tend to outperform large-cap companies.
Large buybacks - that is, repurchase plans that would eliminate a substantial percentage of a company's outstanding shares - typically outperform more modest ones.
Companies that actually repurchase stock during the first year outperform those that don't. (Ironically, the faster a company's stock rises after a buyback announcement, the less likely it is to actually repurchase any shares.)
Companies that are cash rich tend to fare better than those that are cash poor. Some companies even take on debt to finance buyback plans.
Insider buys or sales after a buyback announcement do not appear to have a bearing on a company's stock price.
It's also important to assess a company's general economic health and whether its stock is undervalued, says Fried, editor of the Buyback Letter. A sick company's stock is unlikely to achieve sustained price gains just because of a buyback announcement.
Investors need not agonize over exactly when to buy a promising company's stock. Because much of the gain in share price occurs years after the initial buyback announcement, "You don't have to get in the next day, or the next minute," says Jeff Norman, head of portfolio strategies at Freeman Associates Investment Management.
When to sell is another question. Though Ikenberry's research suggests holding a stock up to four years after the buyback announcement, Fried recommends selling a stock as soon as the company stops making repurchases.
There's no easy way of tracking such purchases now, but the Securities and Exchange Commission has published a draft rule that would require companies to publish the date, quantity and cost of each stock repurchase every quarter. Doing so, the SEC argued, would level the playing field between high-powered investors with access to information on repurchase activity and regular investors with none.
The draft rule, published in December, also would refine current restrictions on when, and in what quantities, a company could make daily stock repurchases.
Separately, the tax-cut package that Congress has sent to President Bush will cut the tax on dividends. That will increase the value of dividends to shareholders and possibly lower their appetite for stock buybacks.
But researcher Ikenberry says buybacks still can benefit investors.
Though not the "screaming steal" some companies may claim in hyperbolic news releases, buybacks generally are "a good news scenario."
Many companies publicly call stock buybacks a cure for the market's failure to properly value their shares, a smart use of excess cash or a way to "give something back" to shareholders. But the private reasons behind repurchase plans are often more complex:
To replenish employee benefit plans. When companies create shares for stock option, purchase or pension plans, they dilute per-share earnings. Buybacks reverse dilution.
To earn scrip for mergers and acquisitions. Many companies use stock to buy other businesses. To boost the stock price before a secondary offering of shares.
To boost the stock price before company executives exercise stock options.
To replace dividends. Slash dividends, and your stock price may plummet. To prevent hostile takeovers. Reducing the number of shares available to outsiders makes takeovers tougher to accomplish.
To change capital structure. If a company finds it cheaper to raise capital via debt rather than equity, buying back existing shares can restore some balance.
Sources: Freeman Associates Investment Management LLC; Times research.
Buyback bonanza
Strong earnings and heavy cash flow made the 1990s a banner period for stock buybacks. Here are the number and value of buyback plans announced each year by Fortune 500 companies. In some cases, some companies announced more than one buyback plan in a given year.
