Stock Buybacks

Just because a company is buying back shares of its own stock doesn’t mean that you should. Companies in the Standard & Poor’s 500 stock index, anticipating a cash windfall from lower corporate taxes under the new federal tax law, are expected to spend $800 billion on buybacks this year—a 50% increase over 2017. And investors often see stock buybacks as strong evidence of a stock’s value—after all, who knows better than a company itself whether its own shares are selling at a good price? There is some logic to the reasoning. Example: The S&P 500 Buyback Index, which measures the performance of 100 stocks in the S&P 500 with the highest buyback ratios, gained an annualized 12.8% in the five years ending March 31, versus an annualized gain of 11% for the overall S&P 500.

But for some companies this year, buybacks that are fueled by tax breaks may mask serious financial weaknesses that wouldn’t normally warrant a big buyback. What to consider before you join a company’s own buying spree…

Make sure the buyback is not a move to divert attention from faltering fundamentals. Look for consistent earnings growth over the past several years and a stable or rising return on equity, a measure of profitability.

Check that the stock is not overvalued. Its price-to-earnings ratio (P/E) should be low relative to its long-term historical average, and there should be clear catalysts for growth.

Attractive companies that have purchased their own stock recently… 

Bloomin’ Brands (BLMN) owns more than 1,200 casual and upscale dining restaurants around the US and 300 in other countries, including the Outback Steakhouse chain.

Interface (TILE) makes modular carpet squares for commercial and residential buildings.

NCI Building Systems (NCS) manufactures metal buildings and roofs for the construction industry.