Dell: Compounding or Destroying Value?

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I'm highly skeptical about the economic value of most share repurchase programs. To see why, look at the following graph of the total buyback dollar amount for the companies in the S&P 500, compared to the average price of the index on a quarterly basis:

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Source: Standard & Poor's and Yahoo! Finance.

Share buybacks for the S&P 500 accelerated in the second half of 2004, culminating in a sharp spike during the first two quarters of 2007 -- just as the stock market was peaking. Conversely, when stocks traded at bargain prices during the worst of the crisis, share buybacks dried up. Then, as stocks became more expensive during the rally that began in March 2009, companies once more became happy to step up the dollar amounts spent on share repurchases.

Still, not all buyback programs hurt shareholders. In order to praise smart capital allocators and shame those who fritter away shareholder capital, I've decided to evaluate individual share repurchase programs. Today, I'm looking at the new program established by computer maker Dell (NAS: DELL) .

How much and for how long?
The new $5 billion share buyback authorization comes on top of another $2.16 billion left over from prior buyback programs. The company has placed no other restrictions on when it will buy shares, or in what amounts.

How cheap is the stock?
Dell's buyback announcement specifically mentions the share price as one of factors that will determine their ability to spend their authorization. That's encouraging because the relationship between price paid and intrinsic value will determine whether the share repurchases are compounding or destroying shareholder wealth. Just how cheap (or expensive) are Dell shares right now? Based on its price-to-earnings ratio, Dell trades at the middle of the pack among some of tech's biggest names:

Company

Forward P/E

Apple (NYS: AAPL)

13.2

IBM (NYS: IBM)

12.5

Dell

8.0

Best Buy (NYS: BBY)

7.0

Hewlett-Packard (NYS: HPQ)

4.9

Source: Capital IQ, a division of Standard & Poor's.

Is this a smart use of shareholder capital?
Dell's price-to-earnings multiple currently lies in the bottom quintile compared to the company's industry peers, the S&P 500, and its own five-year history. With shares trading at 8.0 times its earnings-per-share estimate for the next 12 months, Dell's share buyback program looks like a good use of shareholder capital. In fact, I think it's worth adding Dell to your Watchlist.

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At the time this article was published The Motley Fool owns shares of Apple, IBM, and Best Buy.Motley Fool newsletter serviceshave recommended buying shares of Apple and Dell, as well as creating a bull call spread position in Apple. Try any of our Foolish newsletter servicesfree for 30 days.Fool contributorAlex Dumortierholds no position in any company mentioned.Click hereto see his holdings and a short bio. You can follow himon Twitter. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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