For those of you that actively read my column, you probably know that when a company buys back its stock in the open market that I think it's a terrific sign that even better times may lie ahead.

But the fact is that there are times when companies have ulterior motives for buying back their stock.

For example, when a company has just reported bad news or has seen it's stock languishing for a long period of time, a stock buyback is usually at the top of the list of things to do.


Management and the board are under pressure in those circumstances to boost the stock price, and show confidence in the company.

And what better way to do it then to prop the stock up by buying back shares, particularly on days where it's under pressure.

How can you tell if a company has these ulterior motives?
Well, that's not always so easy because no company is ever going to say that's why their doing it. However, there are times when (at least I think) it's kind of obvious. Take Comfort Systems (NYSE: FIX) one million share buyback announcement made this past Monday for example.

Masking A Not So Good Quarter?

Now I'm sure that management at the well-known HVAC (Heating, Ventilation, and Air Conditioning) services provider thinks that the company is a terrific long term investment. However, the news comes on the heels of another report suggesting that the company's first quarter earnings would come in lower than the previous year's earnings.

Coincidence? Unbelievable good timing?

You decide.

Offsetting Other Potential Negatives?
Incidentally, the news also comes at a "good time" because the company just announced the acquisition of Madera Mechanical – a mechanical contractor. Now to be clear folks, I have absolutely no idea what types of costs might be associated with integrating the company into the fold or if it will be forced to take any charges at all against earnings as a result of the deal. But the fact is that some companies do indeed use stock buybacks to offset acquisition costs. So be aware of that that is a possibility.

Then there's the fact that the company is seasonally in its slowest selling season. Think about it. Folks aren't using their heating systems as much this time of year. But it's not quite hot enough to turn on the air conditioning either. In fact, if this mild weather persists it could put a damper on both first and second quarter earnings. So again, being able to support the shares in the open market via a stock repurchase plan is actually a pretty good strategy.

Masking Expenses/Dilution
Another reason that companies (but not Comfort Systems) are resorting to stock buybacks is due to increased stock options expensing. In case you have no idea what I'm talking about - the idea is that as companies expense the costs that go along with their stock option grants (which are a widely used method of compensation these days), it will reduce earnings.

Follow me so far?

Anyway, in order to offset that reduction in earnings companies have not surprisingly sought ways (such as stock buybacks) to reduce their share counts and boost earnings.

Of course this is nothing new. Over time plenty of companies have been accused of using stock buybacks to limit dilution or offset lackluster earnings. Two biggies that come to mind are Amazon (Nasdaq: AMZN) and eBay (Nasdaq: EBAY).

It's Not Illegal.

But again, it's important to realize that these strategies are entirely within the law. It's just that when a company has these ulterior motives it sometimes misleads investors into thinking that the fundamental picture might be clearer than it really is.

So What Should You Look For In A Buyback?
There are several things:

Ideally, I like to see some tangible evidence that the company is showing fundamental improvements. Increases in gross and operating margins are a good thing, as are new order announcements and/or the pick up of new major customers. Incidentally I also like to see it when executives plunk down a significant amount of their own money on the stock. Those things tell me that the stock buyback program is indeed for real.

Bottom Line
I didn't mention any of these companies to pick on them. In fact, they all have terrific operating histories, and will all probably move higher over the next year. However, I did mention them because I think that there is something that can be learned from their actions.

Long story short, stock buybacks are usually a great sign. But keep an open mind to the fact that some companies have ulterior motives when such programs are instituted.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

Related Articles
  1. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  2. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  3. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  4. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  5. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  6. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  7. Retirement

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
  8. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  9. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  10. Options & Futures

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  3. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  4. Can mutual funds invest in options and futures? (RYMBX, GATEX)

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  5. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  6. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
Trading Center