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A Look At DwotBuyback's

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October 29, 2008 – Comments (8)

Early, as in this Feb 2007 post, I was saying that I didn't think buybacks were good for investors.  They create an artifical demand for the stock that stops once the buy back program is finished, and they tend to strongly enable executives to do what is best for executives rather then shareholders as they artificially inflate the share price with the buyback program and win the "You can't prove I'm a corporate fraudster" lottery as the cash out their options, essentially replacing many of the so called bought back shares.

For BHP it looked like my call was wrong as the share price continued up.  But, my prediction was that the buyback would ultimately reward those who sold out rather then the long term buy and hold investors.  You have to ask yourself how good of an investment it was for investors buying shares back at prices up to $95 when the share price is $36 now?

Early in 2008 I saw an ETF that was just stocks with buybacks, and I made a portfolio with just the buyback stocks, dwotBuyback

For a long time this portfolio looked terrible.  Early I took a closer look and my timing setting it up was awful.  When I looked at a sample of 60 of the stocks in the portfolio and I found that the S&P was down something like 10% from peak when I set it up, but my random sample of 60 stocks were down 30% from their 52 week high, so when I set this buyback portfolio the stocks had already taken a significant hit ahead of my setting up the portfolio.  I forget the exact details, only that my timing was such that this portfolio had an extra 20% to make up for if it was actually going to "win."

This portfolio is "winning."

The math is much easier on this portfolio because they were all set up pretty much the same day.  The S&P is down 30.15% since setting it up and it is down an extra 2.42%, or the stocks are down an average of 32.57%.  But keep in mind, in my sample they were already down an extra 20% from their 52 week highs over what the S&P was already down.

So, I'd say this is a sufficiently big enough sample to say the buybacks have been a disaster for investors.  They simply rewarded the sellers at the expense of the buy and hold investors and they also enabled the stocks to bubble much higher then the S&P.

8 Comments – Post Your Own

#1) On October 29, 2008 at 7:36 PM, Tastylunch (29.48) wrote:

Yeah I dunno if it proves that all buybacks are a bad idea. I think what it does prove is that buybacks shouldn't be done indiscriminately.Certainly Buybacks should absolutely take a back seat to dividends. But if a company accurately judges their stock to be undervalued, than it can be quite good for investors....Certainly does make Microsoft's special dividend a while back look like a better idaea.

I believe I had read that if National City hadn't done their buybacks in 2007 and had instead chosen to retain the cash, they would have had enough cash to survive independently :-(

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#2) On October 29, 2008 at 9:48 PM, UltimateAnalyst (97.19) wrote:

Buybacks are not bad, they are a way for a company to invest in itself.  Yes, you should be careful about the execs taking advantage of it, but buybacks aren't just for a temporary artificial inflation, they mean that the stock is undervalued from the board's perspective and an undervalued stock can make a good long term buy without the added bonus of the stock buyback.

 

However, dwot is right, buybacks should be given a ctritical eye to weight the motives involved. 

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#3) On October 29, 2008 at 10:21 PM, neumann101 (95.62) wrote:

An interesting point, stock buybacks seem to be a variation on "buy high and sell low".  Would you have confidence in a cash rich company that wanted to use funds to buy back stock now that prices are at multi-year lows?

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#4) On October 29, 2008 at 11:11 PM, abitare (40.75) wrote:

Good stuff.

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#5) On October 29, 2008 at 11:46 PM, awallejr (82.99) wrote:

I never liked the idea of stock buybacks.  If the company has extra money either lower debt or give out an extra dividend. 

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#6) On October 30, 2008 at 7:34 AM, ThinkGlobal2 (< 20) wrote:

The question is "If a company has excess cash, how best can it use it?"

The first thing I would like to see is eliminate debt. But what if they don't have any debt? Let's look at some options:

Pay it out as a dividend? Let's say you buy shares at $100 each in a company that has$40/share cash, and the next day the company decides what to do with that cash. You'd get $40/share dividend and the share price would probably drop to $60/share. So you haven't lost.But it hasn't done much for you or the company either.

Pay it out as executive bonuses? Yeah right! Great for the executives, bad for you. But still, it's a tempting option for the decision-makers.

Invest it in something else (property or another type of business)? Probably not, unless it's an investment or property company. I'd expect you would want the company to stick to what it's good at rather than diversify.

Buy a competitor? Maybe. If the competitor is good or can be fixed by teh buyer and price is right, this could improve overall efficiency greatly through economies of scale and reduce competition.But mergers and buy-outs often cost more, are fraught with internal problems and deliver less benefit than expected.

Buy a supplier? Also could be a good thing, especially if the business are closely related and the supply is critical.

Buy a customer?  And alienate the other existing customers? I think probably not.

Invest in itself by upgrading plants and equipment, R&D, training staff, marketing, etc? Could be a great thing if it helps bring new-and-improved products to market, increase margin share or increase efficiency.

Expand with greater production capacity and/or move into other states or countries? Also a goodie. But needs to be done with great caution, especially if venturing outside the home country. Many businesses fail to appreciate the differences in customers, business practices, relationships, laws, and general culture of other countries.

Those are the options off the top of my head, and the one I like best are investing in itself. What do others think?

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#7) On October 30, 2008 at 8:29 AM, Gemini846 (79.95) wrote:

I always wondered why they pay it out as a 1 time dividend. Wouldn't it be better in your $20 example to pay it out say $1 per quarter over the next 5 years?

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#8) On October 30, 2008 at 8:42 PM, dwot (97.29) wrote:

neuman, many of the companies took on debt to do the buybacks.  And I would tend to think now would be a much better time to be doing some buying back.

Think Global, some of these companies generated so much cash from the bubble I think extra dividends would have been good, and then put some aside for times like now.

gemini, so you hang on to the money at a couple percent interest so you can gradually pay it out?  What you suggest would hide future problems that could hide under the dividend still being paid.  

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