Companies that have excess cash on their balance sheets or that have recently borrowed money have a number of things they can do with that cash. The company could plunge it back into research and development, use it for promotional activity, or save it for countless other operational needs.
However, there is another option for spending that cash, and that's for the company to buy back its own stock, and when a company engages in a little repurchasing, the investment community should pay close attention. (To learn more, read A Breakdown Of Stock Buybacks.)
What Makes Buybacks So Special?
Right off the bat, an active share repurchase program says a great deal about where a company's management and board of directors think it is heading. Why else would a company spend millions or even billions of dollars repurchasing its own equity in the open market unless it thought doing so was a wise investment or that its shares were being undervalued by the marketplace?
The mangers know the company better than any one else, and so if they decide that buying back shares is the possible use of the company's excess cash, investors should seriously examine the company's prospects and consider investing some of their own excess cash into the stock.
Coattailing Stock Buybacks Can Be Profitable
There is no guarantee that when a company repurchases its stock that the value of its shares will ultimately climb. After all, in the stock market, anything can happen. However, there are times when mimicking a company that has repurchased its shares can prove to be an extremely profitable venture.
For example, in August of 1998, McDonald's (NYSE:MCD) completed a share repurchase program worth about $2 billion, and commenced a new program at that time as well. If an investor had mimicked the company's decision and purchased shares around that time and held them until the present day, they would have seen the value of their large-cap holding more than double. Not too bad of a return for simply buying and holding the common stock of a well-established company that was already arguably finished the growth phase of its lifecycle and operating in a mature industry.
Another great example is found in Sears (Nasdaq:SHLD). Back in the second quarter of 2003, the retail stalwart spent about $1 billion to repurchase its own stock from the open market. What happened next? Investors that were smart enough to copy Sears' move and hold on to their shares made some serious money. The stock has shot up from the $15 range in June of 2004 to trade at more than $80 by June 2008, producing over 400% of share price appreciation during that time.
All Aboard The Buyback Express
As investors can take away an important lesson from these two examples: coattailing a corporate stock buyback can pay off handsomely if you pick the right company. Here's a shortlist of companies that are already buying back sizable amounts of their own stock, and thus could end up producing returns that rival the likes of Sears and McDonald's.
|Company||Market Cap||Return (TTM)|
|Market Cap and buyback data as of June 5, 2008.|
I think that just about all of the above-mentioned companies have solid potential for growth over the long haul. After all, each is among the leaders in its industry and each has impressive brand equity and a broad footprint. That said, there is one company in particular that piques my interest and that I think is especially worthy of follow-up research for investors looking to coattail a share buyback program.
Burger King Me
Burger King may not have the name recognition of fast food titan McDonald's, but it's close and it's been drawing a large amount of foot traffic despite the waning economy and stiff competition from its fast food brethren. In its third quarter ended March 31, 2008, it managed to grow its revenue line at a healthy 10%.
This was also, the 17th quarter in a row its posted positive worldwide same store sales. Now that's consistency! And when you layer on a healthy share buyback program on top of consistent same-store-sales growth, the result is usually solid long-term share price returns for stockholders.
The Bottom Line
The stock market is full of examples where companies have bought up boat loads of their own stock, and then watches the share price rise steadily in the years to come.
So, when you see a company that is buying it's own stock, it is usually a good idea to do a little research to see if the stock is truly undervalued. After all, as the investors who bought Sears in 2003 and were sitting on 400% returns by 2008 have shown, there is a lot of profit to be had by simply mimicking the share buyback programs of well-run companies.