When financial historians look back at the current bull market, they'll likely call it the "era of the stock buybacks." As I've written several times in the past, companies have been regularly spending $400-to-$500 billion (in aggregate), on a rolling 12-month basis. In fact, buyback programs appear to have been the greatest source of demand for stocks, which means it has a major responsibility for the extended and robust bull market.
Yet the ardor for buybacks may be cooling. As Factset Research noted, after a deep review of share buyback activity in the second quarter, "quarterly buybacks declined year-over-year (-1.1%) for the first time since Q3 2012." On an anecdotal basis, it appears as if buyback activity in the current quarter is also a bit less pronounced than in the recent past, which is odd, considering how many stocks now trade well below their 52-week highs.
Indeed the buyback frenzy has started to generate a bit of a backlash, as The New York Times recently scoffed at Carl Icahn's efforts to compel Apple, Inc. (Nasdaq: AAPL) to pursue a massive buyback. The Economist went so far as to call buybacks "corporate cocaine."
To be sure, it's hard to grasp the logic of buyback plans after a company's stock has already doubled or tripled from the 2009 market lows. Buying shares when they trade near all-time highs is an implicit way of saying "we have no other uses for our money." Worse still, some companies pursued massive buybacks, only to find themselves in a cash crunch later on. Telecom equipment company Nokia Corp. (NYSE: NOK) surely regrets spending more than $2.5 billion in 2007 to acquire more than 100 million shares of its stock, only to find that its stock would go on to plunge in value. Spending the same amount today would have retired more than 300 million shares.
Yet there is still a solid case for buybacks: if the companies in question have very strong balance sheets, positive cash flow and their shares have lost a considerable amount of value, due to short-term issues. With those factors in mind, I took a look at all of this month's buyback announcements, focusing on those that equate to at least 5% of shares outstanding. Only a few stocks stand out as logical share repurchasers.
Let's use Cree, Inc. (Nasdaq: CREE) as an example. I recommended the company's shares nearly a month ago on our sister site, ProfitableTrading.com. That pick came back to bite when Cree subsequently reported tepid quarterly results (though shares have since rebounded back into the low $30's).
I still think Cree faces a bright long-term future and with shares near the 52-week low, management has wisely sought to stem the selling by boosting an existing $300 million buyback to $550 million. With more than $1 billion in cash on hand and a history of positive cash flow, such a move seems to carry little risk (though Cree also announced that its credit line has been expanded up to $500 million, a seemingly unnecessary move).
Companies don't always need to have bulletproof balance sheets to justify buybacks. The key is sustainability of cash flow, which can support buybacks and keep debt at manageable levels. Tribune Media Co. (Nasdaq: TRBAA), which has more than $10 billion in long-term debt, is a great example. The company owns a range of TV networks such as CW and WGN, while also controlling distribution for many Fox affiliates. It's a lucrative niche of the entertainment field: Tribune has generated roughly $400 million (on average) in annual free cash flow over the past four years, so a recent announcement of a $400 million share buyback plan makes senses, especially since shares are now trading nearly 30% below the 52-week high.
We're heading into small-cap earnings season, and later this month, I'll take a closer look at the next wave of buybacks to see which ones hold water.
Risks To Consider: Buyback plans can still look unwise if the market -- and these individual stocks -- fall yet further.
Action to Take --> Buybacks may or may not be a wise use of a company's cash. Yet it's clear that a reduction in the supply of shares has boosted the market in general and can boost per share profits of specific stocks. If Cree or Tribune can materially reduce their share count while they are out of favor, then shareholders will be handily rewarded down the road. At a minimum, their buyback programs mean that their shares will have a source of buying support at a time when few buyers are enticed. That can stop the stock from falling even further.
Share repurchases are not always done right and following this trend blindly can result in a bad investment. Follow the Total Yield investing strategy and you can identify companies with lucrative repurchase programs. This is done by looking at three shareholder-friendly corporate tactics in aggregate. Since 1982, the stocks with the highest Total Yield have returned an average of 15% a year. For more information on Total Yield investing, click here.
This article was originally published on StreetAuthority.com: Smart Buybacks Make These 2 Stocks A Great Value