Your company's buying back stock? Hurray! Or should that be "boo"?
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 that "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 I? 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 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.
Church & Dwight (NYS: CHD)
Soap czar Church & Dwight delighted investors earlier this month when it reported Q3 earnings of $0.66 per share, topping estimates by a good 12%. Revenue, too, was up more than expected, and management added to the holiday-season cheer with a promise to spend up to $300 million buying back its own stock. There was, however, one small problem with that promise.
Church & Dwight doesn't actually have $300 million.
Oh, the company's probably good for the money. It's actually generating positive free cash flow of almost $350 million. But as far as cash in the bank goes, C&D only has about $240 million lying around, and even this is outweighed by its debt load of more than $900 million.
The bigger problem is that at nearly 23 times earnings, C&D's stock looks even more expensive than that of rival Procter & Gamble (NYS: PG) . (Which only costs 19 times earnings -- and you already know what I think about that valuation). The fact is, with a growth rate that barely scratches 10%, C&D shares are pretty badly overvalued in their own right. They're certainly not a big enough bargain to justify spending $300 million on.
Universal Display (NAS: PANL)
Bad as the deal C&D shareholders are getting on their buyback may be, it pales in comparison to the money being blown on buybacks at Universal Display. After surprising shareholders with a Q3 loss earlier this month and suffering a prompt downgrade on Wall Street, the OLED tech specialist tried to stanch the bleeding last week with an announced $50 million buyback plan.
Unlike Church & Dwight, Universal Display has plenty of cash to fund a buyback -- nearly $240 million at last report. This historical money-burner is even generating a bit of free cash flow these days, so that's good news. The problem is that UD just isn't nearly cheap enough to justify buying back stock at today's prices. Shares costs more than 80 times annual free cash flow and a whopping 110 times earnings. So even if the company hits Wall Street's long-term growth target of 25%, it's hard to justify a buyback.
Plus, last time we checked, UD's growth rate was shrinking, rather than expanding. In this month's report, it cut 2012 revenue guidance from $100 million to as little as $80 million. If that's the best UD can do, it probably shouldn't be buying back shares at all.
SciClone Pharmaceuticals (NAS: SCLN)
I don't like to end this column on a down note. Fortunately, this week I don't have to. Earlier this month, SciClone Pharma disappointed investors with a small earnings miss, caused by weakened pricing of its flagship ZADAXIN hepatitis C drug in China. Adding to the worry, revenue guidance for the year tumbled 9%. Regardless, management bulled ahead with a $10 million addition to its buyback plan, which now stands at $16.2 million.
Weak near-term guidance notwithstanding, I see a lot to like in this plan. SciClone boasts a fortress-like balance sheet with $86 million cash and not a lick of debt. Uncommonly for a small biotech, it's throwing off loads of cash -- $65 million over the past year alone -- and is now in its third straight year of improving free cash flow.
Clearly, SciClone can afford this buyback. And with its stock trading for a reasonable 15 times earnings and an even cheaper four times annual free cash flow, I can't think of a better use of SciClone's cash than buying back its super-cheap shares.
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The article 2 Stocks That Are Wasting Your Money originally appeared on Fool.com.
Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of Universal Display. Motley Fool newsletter services recommend Universal Display and The Procter & Gamble Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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