These Dow Companies Still Think Their Stock's a Bargain

These Dow Companies Still Think Their Stock's a Bargain

The Dow Jones Industrials set a new record high during the past week, raising questions among investors about whether U.S. stocks are getting overpriced. Yet judging from where many companies are putting their own money, some Dow stocks still represent bargains.

Companies buy back their stock to reduce the number of shares outstanding, boosting their earnings per remaining share and hopefully helping to increase the share price proportionately. Moreover, unlike dividends, share repurchases only have a tax impact on shareholders who choose to sell their stock, leaving those who retain their shares unaffected. Yet historically, companies haven't always had the best timing in making stock repurchases, missing out on the biggest bargains and sometimes ending up making big share buys near market tops.

Showing you the money
Let's take a look at four Dow stocks that are standing behind their shares with big repurchase programs:

  • Pfizer authorized a new $10 billion stock repurchase program at the end of June. The program comes in addition to about $3.9 billion in authorized repurchases that remain from previous buyback programs.

  • Fellow pharma giant Merck also made a move to buy more of its stock, setting up an accelerated repurchase agreement for $5 billion as part of a broader buyback of $15 billion that the company announced in May. Rather than using overseas cash and paying repatriation taxes, Merck took advantage of low interest rates to borrow money to use for the buyback.

One big advantage that both Pfizer and Merck share in buying back stock is that buybacks reduce the amount of total dividends they need to pay. As a result, even when Merck incurs interest expense to finance buybacks, it can end up being a cash-flow positive move because of the dividend savings. Obviously, the impact is larger when dividend yields are high, but any dividend-paying stock that repurchases its shares gets the same benefits.

  • Meanwhile, in the technology world, IBM announced in May that it had authorized buying back $5 billion more of its stock. With the tech giant seeking to reach the $20 mark in annual earnings per share by 2015, buybacks are a key component of its overall strategy as it seeks to keep reducing the total number of shares outstanding. With the new increase, IBM has $11.2 billion available for repurchases, allowing it to take advantage of recent weakness in its stock to grab up shares at a relative bargain price.

  • Finally, last month, UnitedHealth Group said it would boost its buyback authorization to 110 million shares, representing about 10% of its outstanding share count. Coming in combination with a dividend increase of 32%, the health insurance giant has been doing a much better job of returning capital to shareholders than it did in the past, with its yield rising to 1.6% from much lower levels in the past.

Demand your capital
Despite dubious timing, the benefit of share buybacks is that they prevent corporate management from spending company cash on ill-advised moves like expensive acquisitions or lavish pay packages. As a result, investors should keep an eye on these stocks, as they should see some support under their share prices as long as they don't entirely use up their buyback authorizations.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter: @DanCaplinger. The Motley Fool recommends UnitedHealth Group. The Motley Fool owns shares of IBM. Try any of our Foolish newsletter services free 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 a disclosure policy.

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Originally published