2 Stocks That Are Wasting Your Money

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Your company's buying back stock? Hurray! Or should that be "Boo!"?

According to research conducted by Boston University finance professor Allen Michel, when a company announces it's buying back stock, that stock tends to outperform the market by about 2% to 4% more than it otherwise would have over the ensuing six months.

But multiple studies argue that over the long term, buybacks destroy shareholder value. As the Financial Times recently put it: "the implied returns over a period from buy-backs by big companies would have been laughed out of the boardroom if they had been proposed for investment in ... conventional projects."

So why do buybacks at all? According to FT, management can use them to goose per-share earnings, which benefits company executives who get compensated based on earnings growth. Also, the investment banks that organize and execute buybacks for management get fees and other income from promoting buybacks. As for you and me, though, we miss out on gains unless those purchases cost less than the actual intrinsic value of the shares.

Meanwhile, here in the U.S., CNBC pundit Jim Cramer has blasted how big banks such as Bank of America bought back shares in 2007-2008 -- just before their stocks fell off a cliff. Cramer dismisses the concept of buybacks as buy signals, calling them "a false sign of health ... and often a waste of shareholders' money."

Unfortunately, several of the worst buyback offenders are at it again.

Two bad buybacks
StreetInsider.com keeps a running tally of which companies are buying back stock, and how much they're spending. SI is too polite to accuse companies of actually wasting shareholders' money, of course -- but I'm not. With SI's help, I've come up with two examples of popular stocks that I believe are squandering shareholder dollars on badly timed buybacks ... and one that isn't.

Renren (NYS: RENN)   The first catcall this week goes out to Renren, often described as "China's Facebook." Problem is, that's not necessarily a good thing. Many a Fool has commented on the apparent overvaluation of America's Facebook. Back in June, privately held Facebook shares were trading at an implied valuation somewhere north of $70 billion. Even this nosebleed valuation looks like a bargain next to Renren, which sells for nearly 150 times projected 2012 earnings, and infinity times its current unprofitable state. Yet heedless of the obvious overvaluation, Renren recently got authorization to spend $150 million on a new stock repurchase program.

A Fool can wonder: Might not that cash be better spent fighting off well-heeled and much bigger, more established rivals like Baidu.com (NAS: BIDU) and SINA (NAS: SINA) ? We'll never know. Because instead of using its (read: "your") cash to build out its business, Renren is spending a good chunk of the loot on buybacks.

Yingli Green Energy (NYS: YGE)
I don't mean to pick on China, but our second nominee for worst allocator of shareholder capital of the month also hails from the Middle Kingdom. Yingli Green Energy announced a $100 million buyback plan on Sept. 30. That should be enough to repurchase by one-sixth of its outstanding shares -- and I say Yingli's welcome to 'em. At less than $4 apiece, Yingli shares may look inexpensive relative to, say, American solar shops like SunPower (NAS: SPWRA) or First Solar (NAS: FSLR) -- priced around $9 and $57, respectively. But just last week, analysts at Citigroup went on record predicting Yingli shares will fall as much as 75% over the next 12 months, to a target price of just $1.

I agree. With roughly $800 million in net debt already, Yingli is in no position to go borrowing $100 million more to buy back shares. The company has never generated positive free cash flow from its business. Never. If you ask me, Yingli needs to spend less time desperately trying to shore up its stock price -- and more time figuring out a viable business model.

A better use of cash  Now, I don't want to end this column on a down note, and I did promise to tell you about one buyback program I actually like. That would be the buyback program that Berkshire Hathaway (NYS: BRK.B) announced last month. Unlike Renren, Warren Buffett didn't try to grab headlines with any big numbers. Unlike Yingli, he didn't promise to spend money he didn't have, on shares he didn't need. Buffett simply said that with Berkshire shares selling for close to book value, he's happy to grab as many as he can at prices no more than 1.1 times book, and that he'll happily keep buying until he's down to about $20 billion net cash.

For the record, over the past 10 years, Berkshire shares have averaged a market cap of about 1.6 times book value. In other words, if Buffett can snag shares for 1.1 times book, he'll almost certainly be buying them at a steep discount. And you can too.

Will Renren and Yingli tumble? Will Berkshire go on a bull run?Add all three stocks to your Fool Watchlist, and find out.

At the time this article was published Fool contributorRich Smithdoes not own (or short) shares of any company named above. The Motley Fool has adisclosure policy.The Motley Fool owns shares of Berkshire Hathaway and First Solar.Motley Fool newsletter serviceshave recommended buying shares of Berkshire Hathaway, First Solar, SINA, and Baidu.com.Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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