Monday, April 30, 2012

Buybacks Take A Smarter Tack

Here's a Wall Street Journal article on the recent share buyback behavior of companies in the S&P 500 index. Apparently, companies did plenty of buying when the market was low then backing off as it rallied.

Wall Street Journal: Buybacks Take A Smarter Tack

The fact is companies do not always get this right. The article also points out that buybacks were at record levels as the market was peaking back in 2007. Yet, once stock prices fell dramatically, the buyback activity dropped off quite a bit.

Substantial corrections can happen (and have happened) where shares in general never fall to an unattractive valuation. So I'd be cautious about considering a large generalized drop in market prices, in combination with aggressive buyback activity, to be a reliable indication that shares are being bought back cheap.

A big drop certainly increases the probability that shares are at bargain valuations but hardly assures it.

For too many stocks, even near the bottom of some of the corrections (including larger ones in the past decade or so), the market price relative to intrinsic value provided insufficient or no margin of safety. Having said that, this most recent time there seemed to be quite a few bargains made available by market conditions in the third quarter of last year.

So, at least in this instance, many companies seemed to be getting it more right than wrong.

Effectively executed buyback programs usually have management (and a Board of Directors) who 1) provides a clear indication, through words and past actions, that they know what their shares are likely worth and 2) a track record of buying back shares more often than not when:
- the discount to intrinsic value is substantial,
- the business itself is in a comfortable financial position, and
- other more attractive investing opportunities are not on the horizon.

For long-term investors, large corrections in market prices are always a welcome thing to see. It often creates an environment where the price of individual shares become very attractive compared to intrinsic value.

Long-term investors can naturally take the opportunity to buy more shares when they're at a discount to value, but it's nice to know that management is likely to intelligently do the same with excess cash.

It's good to see the recent buyback pattern but, at least to me, it's not sufficient to look at what companies as a group are doing with buybacks. The track record is just too mixed. Instead, I'd rather look at the buyback behavior of a specific company, especially one that I happen to know its specific strength and challenges very well.

For frequent readers of the blog, of course, this is ground that's been covered on a number of previous occasions.

Adam

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