{"id":36643,"date":"2013-03-05T12:24:32","date_gmt":"2013-03-05T17:24:32","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=36643"},"modified":"2013-03-10T21:33:52","modified_gmt":"2013-03-11T01:33:52","slug":"dont-be-fooled-by-share-repurchases-that-dont-reduce-share-count","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/03\/05\/dont-be-fooled-by-share-repurchases-that-dont-reduce-share-count\/","title":{"rendered":"Don\u2019t Be Fooled by Share Repurchases That Don\u2019t Reduce Share Count"},"content":{"rendered":"

By The Sizemore Letter<\/u><\/a> <\/p>\n

In the world of investing, so many things work better in theory than in practice.<\/p>\n

Executive stock options?\u00a0\u00a0 They are now reviled by investors as a way for management to quietly loot the companies they are paid to steward.\u00a0 When done in excess (which is the rule) they massively dilute shareholders over time.\u00a0 They also encourage short-termism and a fixation on raising the company\u2019s stock price in the short term at the expense of planning for the company\u2019s long-term future.<\/p>\n

But before they became popular in the 1980s, they were touted as the solution to the age-old problem of aligning the interests of shareholders and management.\u00a0 Yes, even before the \u201cdecade of greed,\u201d managers were seen as being self-serving and as managing the company for their own benefit rather than for the good of the shareholders.\u00a0 But if top executives were<\/i> shareholders, then there would be no more conflicts of interests, right?<\/p>\n

Well, it sounded good\u2026in theory.<\/p>\n

Along the same lines, share repurchases have become popular in recent decades as a tax-efficient alternative to cash dividends.\u00a0 Earnings paid out as dividends are taxed twice, at both the corporate and individual investor levels.\u00a0 But when a company uses that same cash to buy back its own shares in the open market, it can boost earnings per share without creating a taxable event.<\/p>\n

And unlike dividends, which are generally paid regularly, stock buybacks can be done sporadically as their cash position allows.\u00a0 Management is often reluctant to raise the quarterly dividend because cutting that dividend if conditions took a turn for the worse sends a very bad signal to the investing public.\u00a0 But buybacks can be done quietly behind the scenes and can be stopped at any time without drawing attention.<\/p>\n

Again, it sounded good\u2026in theory.\u00a0 In practice, companies tend to have awful timing.\u00a0 They buy their stock when prices are high, but in a market panic when prices are low they are often unable to buy because a bad economic outlook causes them to hoard cash. \u00a0In the worst cases, they actually have to issue new stock\u2026at low prices that dilute shareholders.\u00a0 Buying high and selling low; this is not exactly a formula for maximizing shareholder value.<\/p>\n

But the most insidious aspect of stock buybacks is that they often fail to reduce the number of shares outstanding.<\/p>\n

How does that make sense?\u00a0 Simple.\u00a0 The company retires shares bought at full price on the open market to soak up new shares issued at a discount to fulfill employee and executive stock options.\u00a0 It\u2019s highway robbery that is, sadly, perfectly legal.<\/p>\n

How bad are the numbers here?\u00a0 Barron\u2019s reported<\/a> in January that the 500 largest U.S. companies repurchased about a quarter of their equity’s dollar value since 1998. But the number of shares outstanding actually grew<\/i> more than 7%.<\/p>\n

Don\u2019t think that I am against stock buybacks, however.\u00a0 I\u2019m a big fan of them, assuming that the stock is reasonably priced at the time and that the buybacks are actually used to reduce share count.\u00a0 But here, we have a mixed bag.<\/p>\n

I recently highlighted<\/a> three Dividend Achievers<\/strong> that were also reducing their share counts: Wal-Mart (NYSE:$<\/span>WMT<\/a>)<\/b>, Microsoft (Nasdaq:$<\/span>MSFT<\/a>)<\/b> and Intel (Nasdaq:$<\/span>INTC<\/a>).<\/b><\/p>\n

I love all three as long-term dividend payers to drop into your portfolio and forget.\u00a0 But of the three, Wal-Mart has been the friendliest to shareholders.\u00a0 Nearly all of its buybacks have gone to retiring shares, and the company has reduced its share count by a quarter over the past decade.<\/p>\n

Microsoft and Intel have reduced their share counts too.\u00a0 Microsoft has shrunk its share count by 2.6 billion shares, or 23%, in the past decade.\u00a0 But its share repurchases are bigger than that by nearly half, with the rest being used for stock-based compensation.\u00a0 Intel\u2019s performance on this count is also a mixed bag.\u00a0 But overall, I can\u2019t complain too loudly.\u00a0 Despite some dilution from stock-based compensation, both have still managed to shrink their share count while simultaneously boosting cash dividends.<\/p>\n

In any event, the key point to take away from this is that you should take the share buyback numbers you read about in press releases with a good-sized grain of salt.\u00a0 In a vacuum, a share repurchase plan means very little.\u00a0 They must actually reduce share count to be considered \u201cshareholder friendly,\u201d and they should only be implemented when market prices are favorable.<\/p>\n

Disclosures: Sizemore Capital is long WMT, MSFT, and INTC<\/p>\n

SUBSCRIBE\u00a0<\/a><\/strong>to\u00a0Sizemore Insights<\/em>\u00a0via e-mail today.<\/p>\n

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The post Don’t Be Fooled by Share Repurchases That Don’t Reduce Share Count<\/a> appeared first on Sizemore Insights<\/a>.<\/p>\n

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