David Fried
David Fried, CEO of Fried Asset Management, Santa Monica, California, and publisher of The Buyback Letter. BuyBackLetter.com
When a company buys back lots of its own stock from shareholders, that’s often a compelling reason to invest because it reduces the overall number of outstanding shares, thereby boosting earnings per share. And it’s a signal that management believes the stock price will rise. In 2015, buybacks among US companies are expected to total a record $1.1 trillion, which is helping to sustain the aging bull market. But when a big buyback program is announced or executed, it doesn’t always result in higher stock prices. Before you consider any buyback as a reason to buy shares yourself, do the following…
Wait for the company to actually start buying. Nearly 25% of companies that announce a buyback program don’t follow through, often because the business ends up not doing as well as had been expected. Sometimes companies reduce the level of buybacks, which means that you should reevaluate whether to invest.
Determine whether the buybacks will actually reduce total shares outstanding. This isn’t always the case. Example: Wireless-communications-equipment supplier Qualcomm has spent more than $13 billion in buybacks over the past five years, but the number of outstanding shares has increased by 2% because the company has issued nearly 100 million new shares to management. To represent an investor advantage, buybacks should be large enough to reduce outstanding shares by at least 5%.
Do your own research. Just the fact that a company is buying back shares doesn’t make the stock a bargain or mean that the company has strong growth prospects. It may be buying back shares as a way to please shareholders and attract investors despite a disappointing financial outlook. And sometimes a company chooses to buy shares that turn out to be overpriced. Research the company thoroughly, including measures of the stock’s valuation in relation to the company’s outlook.
