Review & Outlook

Our take on the investing, financial, & economic themes of the day

All Stock Buybacks Aren’t Created Equal

6 August, 2014 by Matthew O'Brien, Ph.D. in Commentary

Companies are often poor buyers of their own stock, since generally they tend to buy near market highs.  This is one reason why share repurchases can be treated by investors with some suspicion.  Another reason is that buybacks are sometimes timed in order to cancel out the shareholder-diluting effects of stock option plans that compensate management.  In previous posts I’ve commented on the rise of stock buybacks since the financial crisis, and in particular, how central bank easy money policies have perversely incentivized companies to buyback their own stock instead of making capital investments and new hires — just the opposite of the stated goal of quantitative easing.

When the Federal Reserve and other central banks use discretionary policies to influence short-term market behavior, they introduce paralyzing uncertainty into the financial system that distorts the pricing mechanism and prevents businesses from planning for and investing in their future.  As a result, companies choose to accumulate cash and wait, or they spend their cash on share repurchases (and to a lesser extent, dividends), since share repurchases get an immediate bang for the buck by nominally increasing earnings per share, which “returns shareholder value,” as they say.

Even amidst this economic environment in which buybacks generally are incentivized, however, it’s possible to separate the reasonable buyback programs from the unreasonable ones.  A recent article in Bloomberg offers a nice case in point.  In the reasonable category is Apple (AAPL) and its decision over the past year to spend $34 billion buying back its shares.  Apple had a hugh cash haul, a fortress balance sheet, an impeccable brand, a diversified product range, and a relatively low stock price relative to its earnings and profit margins.

The iPhone maker is up 25 percent since it spent $18 billion on its own shares between January and March and rallied 32 percent after a $16 billion buyback in 2013. Those are the highest four-month returns among the 20 biggest quarterly repurchases by any company since 1998, according to data compiled by Bloomberg and Standard & Poor’s.

I wrote about Apple’s impressive comeback earlier in June.  Bloomberg continues:

Apple’s $18 billion repurchase in the first quarter and the $16 billion it spent between April and June of 2013 are the two biggest buybacks by any company in data compiled by S&P starting in 1998. They came as the stock advanced as much as 77 percent over 15 months after falling to a 16-month low in April 2013.

It’s important to note that Apple chose to finance its buybacks in part by issuing debt (against its cash held overseas).  This strikes me as an unhealthy practice, but it’s hard to fault Apple’s management, since this sort of financial engineering is just what the Fed has encouraged.  In any case, the debt financing aside, Apple timed its repurchases masterfully and seems to have succeeded in genuinely rewarding its shareholders.  Furthermore, Apple hasn’t sacrificed its ability to invest in its future.  It still has a big cash horde, and investors are eagerly awaiting immanent new products, such as the iWatch and the larger screen iPhones.

Bloomberg contrasts Apple with a company such as the retailer Bed Bath & Beyond:

In July, Bed Bath & Beyond Inc. (BBBY) paid a premium in the bond market to buy its shares as the retailer tries to stem a 23 percent plummet this year.

The seller of home furnishings, whose debt is rated Baa1 by Moody’s Investors Service and A- at Standard & Poor’s, issued $1.5 billion of bonds July 14, including $300 million of 10-year notes that yielded 3.75 percent. That was higher than the 3.58 percent average for bonds from U.S. retailers with similar credit grades and maturities.

Since reaching a record of $80.48 in January, Bed Bath & Beyond’s stock has fallen to $61.70.

Bloomberg notes that Bed Bath & Beyond’s debt-financed buyback seems to be driven as much by management’s concern to spurn activist investors as it has been to benefit the long-term shareholders of the company.