Buybacks Again? This Time the NYT Does It Right

As my readers know, I've been pretty frustrated by much of what has been written in mainstream media concerning stock buybacks. And this frustration has clearly been reflected in a few of my recent posts (calling out both the NYT and the WSJ). The root of my frustration has been the combination of throw-away generalizations ("buying back shares increases EPS"), inadequate exploration of the reasons motivating buybacks and the true financial impact of different types of repurchase programs. So when I rolled out of bed this morning and picked up the Sunday New York Times Business Section, I was pleased to see Barry Rehfeld's take on the subject. Finally a piece that has some of the texture and depth required to undertake a well-reasoned review of the topic! My coffee tasted extra-good as a result.

So what makes today's article of higher quality and containing more relevant and usable content than the others?

1. Acknowledging that all buybacks are not created equal. The thesis of buybacks always being a buy signal is analytically refuted using data, which is pleasing. He then presents concrete examples of different types of companies undertaking buybacks, empirical research on the results and investor perception of different types of buybacks (large, chunky repurchases versus long-term, steady buybacks).

Zero in on the right stocks, though, and the gains can be significant. This is seen in small undervalued companies — those with high book-to-market-value ratios — where management says it is buying back shares because they are bargains. Theo Vermaelen and Urs Peyer, professors at Insead, the French business school, tracked the 50 stocks that best met those conditions in every year from 1992 to 2002 and found that they produced gains 65 percent greater than those of the S.& P. 500 index over the next four years.

How much stock is being bought, and how often, can influence the share price. Bigger purchases are generally thought to be better, and the flexibility of long-term regular buying is often seen as a more confidence-building signal for the market than buying back shares all at once.

Now this is good, useful stuff backed up by data. Makes it more persuasive, huh?

2. Considering the way a buyback is financed as being a relevant data point. This is a subtelty I've discussed at length but has been conspicuously absent from the recent articles on the topic. Barry raises the issue and provides an example of when a debt-financed repurchase can make sense (which it absolutely can).

How a company finances a buyback is worth considering, too. Free cash flow generally trumps debt, but again, it depends on business conditions. The Tribune Company recently did a buyback with borrowed funds, but for Tim Fidler, director of research at Ariel Capital Management, it was only one more reason to invest in the company, whose share price was battered in the previous two years.

“We’re contrarians,” he said, adding, “money is still relatively cheap, and we thought the balance sheet could handle it.” He also said that he thinks the company’s earnings potential justifies a higher stock price. If the price doesn’t rise on the public market, he said, there is plenty of private interest in a purchase of the company, or individual parts of it.

3. Analyzing whether or not a buyback announcement is actually followed through in the market, and if there are other factors offsetting the impact of a buyback program. This is an issue that has been discussed in previous eras with great clarity and insight, but has somehow been relegated to the scrap heap by today's writers. This is a sickly important point. Really. Also, Barry raises the issue of option exercises and its dilutive impact on buyback programs (i.e., is a company simply immunizing the effect of option exercises or actually implementing a net repurchase of shares).

In general after buyback announcements, potential investors should check that the companies are actually buying back stock. “They don’t have to and they may not,” said Robert Leiphart, a Birinyi analyst. “Or they may buy less than they said they would or they buy all they say they would, but do a secondary stock offering at the same time that’s bigger than any buyback.”

There are darker issues in this numbers game to consider, too. Buybacks may serve only as a cover for senior executives to exercise their options, buy their shares at a huge discount and sell them at market value. Such transactions can be a net loss for the company, with the number of shares remaining unchanged in the end.

Indeed, with so many ways to shuffle shares, it’s not surprising that Birinyi also found that, taken together, the S.& P. index companies issued 133 percent more stock than they bought for the 10 years ended in 1995. Two professors at Georgetown, Allan Eberhart and Akhtar Siddique, found in a study of more than 7,000 buyback announcements from 1981 to 1995 that the number of shares in the companies making the announcements actually increased by 24 percent, on average.

The article goes on to provide more concrete examples, which are very helpful in framing when a buyback is a viable signal for investment. All in all, a very well-written, well-researched, insightful article. Bravo, Barry. And thanks.