2 Stocks That Are Wasting Your Money

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

But over the long term, multiple studies show that buybacks actually destroy shareholder value. CNBC pundit Jim Cramer cites the example of big banks that bought back shares in 2007 and 2008 -- just before their stocks fell off a cliff. Far from 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 bonuses based on "performance." Also, the investment banks that run buybacks earn income and fees from promoting them. But you and me? Unless the purchase price is less than the shares' intrinsic value, we miss out.

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 uncovered two examples of popular stocks that I believe are squandering shareholder dollars on ill-timed buybacks -- and one stock that isn't.

Qualcomm (NAS: QCOM) During the 1928 presidential campaign, Republican party leaders promised voters would enjoy "a chicken in every pot" if Herbert Hoover should be elected. Fast-forward 84 years (and 21 elections), and shareholders of Qualcomm are looking for something more like a chip in every smartphone.

But investors aren't the only ones enamored of Qualcomm stock. Turns out, Qualcomm likes itself pretty well, too. Earlier this month, the company announced it would begin buying back $4 billion worth of its own stock.

Can Qualcomm afford to spend so much on itself? Sure it can. The company's got $11.5 billion in cash and equivalents burning a hole in its pocket, along with nearly $6 billion more rolling through the door every year. But should Qualcomm be buying back stock? That's a trickier question. With a P/E ratio of 25, the stock looks pretty pricey. And as optimistic as management is about its prospects, most Wall Street analysts agree that Qualcomm will struggle to achieve even 15.5% long-term growth.

Paying 25 times earnings for 15.5% growth isn't ordinarily a winning investment for value investors. I fear it won't work out much better for Qualcomm shareholders.

Deckers Outdoor (NAS: DECK) If Qualcomm's decision to repurchase shares is questionable, though, then Deckers' decision to spend $100 million on its own stock looks downright dumb. At a P/E ratio of 13.5, the maker of don't-call-'em-a-fad Ugg boots and accessories may look cheaper than Qualcomm, but this stock has serious "issues."

Qualcomm has so much cash it can almost afford to waste it. Deckers, not so much. While its bank account may look flush ($264 million in cash), Deckers generates no free cash flow at all, instead burning cash -- about $25 million a year, at last report.

Heedless of the cash outflows, Deckers sees no harm in drawing down cash levels even further. Why not? Probably because its sales were so very strong last year -- up 37.5% in comparison to 2010 levels. But here's the thing: As fast as sales are growing, uncollected bills (accounts receivable) and unsold merchandise (inventories) are growing even faster. A/R for the past 12 months were up 66% over 2010 levels, and inventory levels doubled.

Analysts remain bullish on Deckers, predicting 17% profit growth at the company. Don't believe it. Between a warm winter sapping sales strength and the discounting necessary to move stale inventories of unsold, unwanted boots, I see Deckers' share price retracting in coming quarters. I'm so convinced of this, in fact, that I'm assigning a negative CAPScall to the stock today.

Applied Materials (NAS: AMAT) Now, I don't like to end this column on a down note. Fortunately, I have spotted one company out there that's spending its shareholders' money prudently. Applied Materials recently announced plans to spend $3 billion on share buybacks, and to me this looks like a good value.

Applied Materials boasts a reasonable P/E ratio of 11; conservative, achievable growth rates of 9%; and a strong dividend payout of 2.9%. These numbers alone would make the stock a buy in my book, but Applied Materials boasts the further advantages of a rock-solid balance sheet and free cash flow that exceeds reported income by 27.5%. The stock's a bargain, and management is right to be buying it at today's discounted price.

For the record, I'm assigning a positive CAPScall to Applied Materials as well. (Think I'm wrong? Follow along.)

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