Company Stock Repurchases/Buybacks ...What's the Deal?

Companies pay cash dividends with earnings from operations. Frequently they repurchase their shares on the open market as well. Why?

Because the shares are viewed as a good investment by the company. In simple terms, for those shareholders who want to sell at the offered price, the company will purchase their shares. And for those shareholders who don't want to sell their shares at the offered price, they end up owning a little more of the company after the company completes its buyback of shares from other stockholders.

The decision is always left entirely up to the shareholder as to whether to sell or retain ownership of his shares when companies engage in stock repurchase programs. But the existence of these programs is often a strong signal from the company's leadership that the company expects to do well over time and also possesses the needed financial resources to return considerable cash to shareholders through both dividend payments and stock repurchases as well.

Buybacks Rule the Day is subtitled 'With Cash on hand, Companies Invest in Their Stocks as Business Spending Slows:'

"Flush with record levels of cash, the biggest U.S. companies have invested hundreds of billions of dollars . . . in their own stock.

American companies bought back $274 billion more shares than they issued in the year (2012) through September . . . . And the spending spree looks set to continue, a sign that companies have the cash to put to work but don't yet see an economic case for using it to expand their businesses or create jobs. . . .

"Investing in the existing business comes first," said Mike Jackson, chief executive of AutoNation Inc., the country's largest chain of car dealerships. "But you can create a lot of value when you buy stock when there are dislocations in the market."

In the past year, AutoNation spent nearly $750 million buying back stock. That took 23 million shares off the market, reducing the dealership chain's outstanding stock by 15%.

While the move consumed cash, it also boosted the company's earnings per share, a figure closely watched by investors. AutoNation's net income for the nine months ended Sept. 30 rose 10% to $233.2 million, while its earnings per share jumped 30% to $1.84.

Some of the spending on buybacks is just financial tinkering—interest rates on borrowed money are cheaper than paying dividends, so companies take on more debt to eliminate some of their shares.

But it's also an exercise that boosts per-share profits without creating more productive capacity or new jobs, revealing a lack of confidence on the part of executives to commit to new projects while the global economy remains sluggish.

AutoNation's Mr. Jackson said the buybacks didn't come at the expense of investments in the business. . . .

The company bought so much of its own stock because it thought the market was too pessimistic about the outlook for U.S. auto sales, Mr. Jackson said. "We felt our stock was undervalued, so we purchased aggressively, and our view played out," he said.

In fact, companies appear to be the only net buyers of U.S. listed stock . . . (an investment advisor) analyzed data from the Federal Reserve and has concluded retail investors and stock-focused mutual funds have been net sellers . . . .

Safeway Inc. is a dramatic example of that dynamic. The second-largest U.S. supermarket chain spent more than $2 billion in the year to Sept. 8 buying back stock, reducing its equity base by 29%.

It paid for the program in part by borrowing $700 million last year.

The move had a big impact on the company's earnings per share for the first nine months of this year, which jumped 65%, while net income for the period only rose by 17%.

"We are still spending on capital expenditure, and we will also invest in our employees and give them more hours as sales grow," a Safeway spokeswoman said.

The supermarket chain plans $900 million in capital spending this year to open new stores, remodel others and spruce up in-store pharmacies. Last year, the company spent $1.1 billion, or about 2.5% of sales.

Capital spending by members of the Standard & Poor's 500 index had been running ahead of (2011's) pace, but has slowed recently, with broader business investment falling . . . .

U.S. nonfinancial companies are sitting on more than $1.7 trillion in cash combined, according to the Federal Reserve, but they are holding back on investments in assets like building, equipment and software amid concerns about demand in key markets like China and Europe.

Honeywell International Inc., for instance, expects sales growth of just 1% to 3% next year excluding the impact of acquisitions and currency movements. In announcing the outlook, Chief Financial Officer Dave Anderson described the macro environment as "challenging and uncertain."

 

The maker of aerospace components and turbochargers has said it is replacing just one out of every four workers who leave because of the economic and political uncertainties.
 

The company also recently raised its dividend and plans to buy back 5 million shares in the fourth quarter of (2012) and the same amount (in 2013).

International Business Machines Corp. has one of the biggest share buyback plans. The company plans to buy back $50 billion of its own stock in the five years to 2015. In the past year, the company reduced its shares outstanding by 4.9%.

The company also plans to pay out $20 billion in dividends over the five year period.

At the same time, IBM has been making a string of small acquisitions to expand in software and has increased spending on research and development.

"Organic growth is absolutely the most valued prize," said Jim Russell, senior equity strategist at U.S. Bank Wealth Management. "That may not be viable in the slow growth economy with so much uncertainty coming out of Washington."

Summing Up

Stock buybacks are a form of dividend payment to shareholders.

Those shareholders who wish to sell can do so.

Those who choose not to sell end up owning a bigger slice of a smaller pie.

The basic idea is that the company then becomes worth more to each remaining shareholder.

Then when the shareholder subsequently sells his shares, he will realize a larger capital gain on the sale of his shares than he would have if the prior stock repurchases had not been made.

My view is that stock buybacks are a nice complement to cash dividends and are good for shareholders, regardless of whether or not they choose to tender their shares to the company.

They signal a financially strong and confident company with a substantial amount of cash generating capability --- always a good thing for shareholders.

Thanks. Bob.