Your company's buying back stock? Hooray! 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 over the long term, multiple studies show that buybacks destroy shareholder value. CNBC pundit Jim Cramer cites the example of big banks that bought back shares in 2007-2008 -- just before their stocks fell off a cliff. Far from being buy signals, Cramer calls buybacks "a false sign of health ... and often a waste of shareholders' money." Indeed, the Financial Times recently warned: "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 run buybacks at all? According to FT, management can use them to goose per-share earnings, which helps CEOs earn performance-based bonuses. And the investment banks that run buybacks for management earn income and fees from promoting buybacks. But you and me? We miss out on gains unless the purchase price is less than the intrinsic value of the shares.
And we're about to miss out 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 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 ill-timed buybacks -- and one idea for how they could do better.
Mosaic (NYS: MOS) The first catcall this week goes out to Mosaic. Last week, the Pharaoh of Fertilizer announced that it's buying out the final 21.3 million-share tranche of shares owned by trusts associated with former parent company Cargill. The deal helps the Cargill trusts to exit their Mosaic stake well ahead of schedule. Mosaic is claiming a win here, too, arguing that buying its own shares "represents one of the best investment opportunities we've seen."
Don't believe it.
Sure, Mosaic's sitting on a big pile o' cash. But is spending $1.2 billion to buy shares at $54.58 a pop really the best use of that cash? I think not. Sure, on a P/E basis, Mosaic looks cheaper than archrival PotashCorp (NYS: POT) . But at 8 times earnings, it's trading on par with the valuations at Agrium (NYS: AGU) or CF Industries (NYS: CF) . I'd also point out that from the perspective of free cash flow, Mosaic's much more expensive than it looks. Its $1.1 billion in trailing FCF today amounts to less than 40% of the company's reported net income. To top it all off, would you care to guess how much these $54.58 shares cost on the open market today?
Try $51 and change.
Sysco (NYS: SYY)
Meanwhile, an even more egregious misuse of shareholder cash is ongoing at food-service provider Sysco, which last week announced a plan to buy back 20 million shares. That's $540 million worth at today's prices. Here we have a stock that costs nearly 14 times earnings but that most analysts fear will grow at barely half that rate over the next five years -- just 7.3%.
Like Mosaic, Sysco is a weak cash producer. (Its $400 million in trailing free cash flow amounts to just 35% of the net income it claims to have earned.) Unlike Mosaic, Sysco is swimming in debt ($2.3 billion, net of cash) and in no position to be running around, wasting what little cash it has left. The stock's down 3% already this year, and I think it's going down even more.
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 company that's making better use of your money. That would be Altria Group (NYS: MO) . The Sultan of Smokes hit earnings targets late last month and burned right past consensus expectations for quarterly sales. Doubling down on success, Altria announced that it will buy back $1 billion of shares -- and I think that's a great idea.
Why? At 16 times earnings, but only an 8% growth rate, Altria may not look like an obvious buy. But unlike the companies I've discussed so far, Altria's free cash flow fully backs up reported earnings. (In fact, it generates a bit more cash than it claims as net profits.) Altria also pays a massive annual dividend yield of 6%. Buying back shares will both boost per-share earnings at Altria and save the company a boatload of cash that otherwise would have gone to dividend checks. (Incidentally, it'll also boost EPS.)
If you ask me, paying 16 times earnings and 16 times free cash flow for a 6% dividend payer that everyone thinks will grow at only 8% but just finished proving it could grow much faster is a smart buy for management -- and for individual investors as well.
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At the time thisarticle was published Fool contributorRich Smithdoes not own (or short) shares of any company named above. The Motley Fool owns shares of Altria Group.Motley Fool newsletter serviceshave recommended buying shares of Sysco. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.
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