Stock Buybacks Are for Dummies Except Right Now: David Pauly

Buybacks are bunk -- usually. Chief executive officers who repurchase their companies’ shares follow the dictates of Wall Street, lacking the imagination to use their cash more wisely.

Today’s low stock prices, however, open a window for sensible buybacks.

Stocks comprising the benchmark Standard & Poor’s 500 Index on average trade at 15 times earnings. That’s about half of their price-earnings ratio in 2001 and compares with a P/E of 23 as recently as December.

The 30 companies that make up the Dow Jones Industrial Average now have an average yield of 2.6 percent, about the same as the yield on the 10-year U.S. Treasury note, considered a safer, more conservative investment.

Stocks such as Intel Corp., McDonald’s Corp. and Procter & Gamble Co. now have a dividend yield that’s even higher, making them attractive to investors who think the run in Treasuries and other bonds is over.

CEOs, many serial repurchasers in the past, are already leaping back into the game. Share buybacks have increased for the last four quarters, according to Standard & Poor’s, which does stock research along with its bond-rating activities. S&P said it expects buybacks in 2010 to exceed $300 billion, compared with $137.6 billion last year.

Easy Money

Many companies borrow at today’s low interest rates to finance share repurchases. Microsoft Corp., the world’s biggest software maker last week said it would borrow as much as $6 billion to finance buybacks and pay higher dividends. Though Microsoft is cash-rich, it’s borrowing because much of the money is tied up overseas.

ConocoPhillips, a Houston-based oil company with a market value of about $83 billion, just arranged the sale of $2.4 billion of shares in Russia’s OAO Lukoil, earmarking the money to repay debt and repurchase its own stock, which now yields almost 4 percent.

For a time, at least, CEOs can buy back shares for fundamentally sound reasons. Their shares look like bargains. Buybacks reduce the number of shares outstanding, increasing earnings per share. That’s what Wall Street analysts like. In their minds, buybacks rank right up there with the firing of workers to cut costs.

Options in Mind

Higher earnings per share tend to lift stock prices. CEOs will tell you that this is what buybacks are all about. They tend not to mention that the process also keeps their stock options in the money.

Companies hot to buy back shares also do it when their stocks are overvalued, though they can argue that by repurchasing regularly, the average price they pay is reasonable.

Continual demand from ongoing buyback programs puts a floor under a company’s stock. Exxon Mobil Corp., the king of buybacks, repurchased $142.8 billion of its stock since late 2004, according to Standard & Poor’s. That’s a lot. The oil giant’s total stock market value is about $314 billion.

Similarly, International Business Machines Corp., with a market value of about $170 billion, bought back $61.7 billion of its shares in the same period, making it a ready buyer for investors who wanted to sell.

Buybacks, while rational now, will continue long after stock prices recover to a level where smart CEOs should put their money to better use.

We’ll never know if cash spent on expansion or higher dividends would have done a better job of increasing share prices.

(David Pauly is a columnist for Bloomberg News. Opinions expressed are his.)

To contact the writer of this column: David Pauly in Normandy Beach, New Jersey dpauly@bloomberg.net

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net