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. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  2. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  3. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  4. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  5. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  6. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  7. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  8. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  9. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  10. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  1. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  2. 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 >>
  3. 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 >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!