Share buybacks are just one of the many ways companies can reward shareholders. In a buyback transaction, a company repurchases a set amount of shares on the open market (or through a tender offer) in order to reduce total share count. This causes the total float amount of shares to drop, and the value of each outstanding share to increase. Earnings per share and returns on equity are enhanced. Based on the P/E ratio, the company that completes a buyback is now less expensive than it was prior to the repurchase, despite the fact that there was no change in earnings. (For more, see A Breakdown Of Stock Buybacks.)
IN PICTURES: Eight Ways To Survive A Market Downturn
Not All Buybacks are Created Equal
During the bull-run in 2007, over $600 billion dollars were spent by corporations on share buybacks. However, during the recent crash, while shares of company stock have been cheap, only $31 billion worth of buyback transactions have taken place. Most firms have been hoarding cash to get through the crisis, and in doing so they have fallen victim to a common rookie mistake of buying too high. A perfect example of this has been Walt Disney (NYSE:DIS). During 2008, the house of mouse spent nearly $4.5 billion dollars on a buyback program with its shares trading at an average P/E of 15.4. Conversely, the company has only repurchased a small $104 million worth of shares in 2009 while trading at a 10.6 P/E. What's even more puzzling about the Disney transaction is that the company will issue more than 60 million new shares to help furnish its recent purchase of Marvel Entertainment (NYSE:MVL), which it has promised to repurchase over the 12 months after the deal closes. These shares will most likely be at much higher prices, as the economy seems to be slowing restarting.
Finding the "Good" Repurchases
Unlike the Disney transaction, there are a select group of companies that have been making the right moves in the buyback territory. There is an exchange traded fund designed to track firms that repurchased at least 5% or more of outstanding shares for the previous 12 months. While the PowerShares Buyback Achievers (NYSE:PKW) maybe a good fit as an overall portfolio diversifier, we are looking for corporations that repurchase shares cheaply, not just on a continuing basis. Investors can be better served on an individual company to company basis.
Two Buyback All-stars
Lab-equipment maker Thermo Fisher Scientific (NYSE:TMO) is a dominant player in the growing industry. Thermo's equipment is used by pharmaceutical manufacturers and various universities in generic, chemistry and other life science applications. The company is a pick and shovel play on the growing health care industry. Aside from that growth, the firm's management has been smart in allocating its capital. Thermo only spent $187 million on buybacks in 2008, when its stock traded at a P/E of 18. The company doubled its efforts in the first half of 2009, spending $415 million buying buy stock at a much cheaper P/E of 11.7.
For-profit education is gaining traction once again, as the nation's high unemployment rate has forced many workers to return to school to find new skill sets. University of Phoenix operator Apollo Group (Nasdaq:APOL) returned to school as well purchasing 4.5% of its outstanding shares in early 2009. The stock was trading at nearly an 18% discount based on P/E versus the previous two years. Apollo, like its peers such as DeVry (NYSE:DV), should continue to see higher enrollment as people still look for higher paying jobs.
The Bottom Line
Buybacks can be wonderful for shareholders, if done properly. However, just like most retail investors, a good number of companies fall within the trap of buying too high instead of when shares are more reasonably priced. Corporations, that allocate capital better and purchase low, show that management is on the side of the shareholders. Both Apollo Group and Thermo Fisher are examples of those types of managements. (For related reading, see How Buybacks Warp The Price-To-Book Ratio.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!