Buyback Fervor: Are CEOs Sending a Message to Investors?

By: Dr_Jeff_Lewis

American businesses appear to be more confident than ever that their future is brighter than the market suggests.  Now that stocks are on fire-sale, according to some investors, companies are buying at an adjusted valuation 15% lower than the start of the credit crisis.

In 2011, the nation's publicly-traded companies have invested some $453 billion in share repurchases, making 2011 one of the top three biggest years for buybacks.  The last time companies were so eager to return profits to shareholders through large-scale buybacks was in 2006 and 2007, right before the burst of the housing bubble.  The current buyback pace is running at 70% higher than in 2010.

Messages in Buyback Programs

Companies favor buybacks for any number of reasons, some of which are positive, and some of which show signs of a weakening economic climate.  Here are some of those reasons:

1) Earnings volatility - Companies usually favor buybacks during periods of volatility in earnings.  Not only do share repurchases set a price floor under a company's stock, but repurchases are also favorable to dividend policies.  In agreeing to open-ended share repurchases, companies do not have to be so public about moving cash.  Dividends, which are far more public than buybacks, require continuity and consistency; otherwise, investors who chase yield leave inconsistent dividend payers for other opportunities.

2) Earnings weakness - One of the greatest failures on Wall Street is the inability to compare earnings from one period to another.  Share repurchases allow companies to increase their earnings per share, as the same amount of earnings spread to fewer shares means better headline EPS figures.  Repurchases can be used to temporarily cover up weakening corporate earnings, as many analysts rarely care to what extent a company is growing its bottom-line.

3) Better outlook - It is quite possible that companies have a much rosier internal projection for the future than Wall Street.  Today, companies are generating three times as much cash, but sell for lower price to earnings ratios than found during the last wave of buybacks.  Remember, despite the troubles for employment, many S&P500 components have managed to improve earnings by cutting wages, workforce numbers, and general inefficiency.  While the consumption-side of the economy remains weak, corporate profits are still rising.

4) Shedding cash - Perhaps the strongest underlying component of capital structure decisions today is the relative benefit of cash on hand and the minute cost of debt.  Companies hold record amounts of cash, much of which is invested in cash equivalents, which lose value to inflation with each passing day.  Some companies, such as Amgen, find that the low-rate environment is reason enough to borrow cash for share repurchases--effectively levering the company due to favorable interest rate policy.

The Market's Double-Speak

Past history tells us that insiders are generally poor stewards of investor capital and even poorer predictors of when their companies are or are not undervalued by the market.  What happens at the micro-level isn't entirely contradictory to the macro-message of debt and contagion that is sweeping through the headlines.  In fact, the reality is that Wall Street's most recent earnings growth is due to efficiency, not further investment, or true economic growth.  Companies know what investors know: there is no reason to hold cash in the current market environment.

By Dr. Jeff Lewis

Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of Silver-Coin-Investor.com and Hard-Money-Newsletter-Review.com

Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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