How You Can Profit From The $1 Billion Buyback Playbook

By (dsterman),

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Here at StreetAuthority, we spend a great deal of time focusing on dividend-payingstocks .

Risingdividend payments have become the hallmark of the moderninvesting era as companies begin to return unneededcash back to its rightful owners -- the shareholders.

Many companies are so flush with cash and robustcash flow that they continue to devote huge sums ofmoney tostock buybacks as well.

For investors, these buybacks can help restore luster to a flagging stock price. A few weeks ago, I said that Apple (Nasdaq: AAPL) could boost its lackluster stock with a massive buyback.

I suggested the company use its own cash and also borrowfunds to amplify the buyback's effectiveness.

Well, that's precisely what Apple did, andshares have risen more than 10% in just those past few weeks.

I looked at this past month's other major buyback announcements to see whether any other stocks might benefit as Apple has. I found 12 companies that have recently announced a share buyback of at least $1 billion, or a buyback large enough to reduce the share count by at least 7%. Here's what I found.

Right away, you'll notice two standouts in terms of buyback spending as a percentage ofmarket capitalization . Both Denny's (Nasdaq: DENN) and Rent-A-Center (Nasdaq: RCII) are in a position to significantly shrink their share counts. As is the case with Apple, these companies are willing to take on somedebt to buy back stock, which may seem like a risky move. But both of these companies are generating stable financial results, and as long as theeconomy doesn't stumble badly, these moves could really pay off.

Nearly two years ago, I spotted the early signs of aturnaround at Denny's and noted management's plan to buy back shares. Since then, the share count has fallen by around 5% to 97 million.

Still, for a company that has generated $40 to $50 million infree cash flow in each of the past two years (along with just-releasedguidance of a similar amount of free cash flow for the currentyear ),earmarking another $120 million toward stock buybacks is a pretty bold stroke. That would cut the current share count by a quarter, setting the stage for very robust per-shareprofit gains , even ifsales growth is muted.

How can Denny's afford to do that? Well, as the company's free cash flow has strengthened, Denny's has been able to secure much lower borrowing terms from itslenders , and the company's board has decided to convert those interest expense savings into buybacks.

I took a look at this furniture and appliance rental chain in late 2010, noting that a then-announced buyback plan could shrink the share count by up to 15%. Indeed, the share count has now moved below 60 million. It stood at 70 million in 2006 and 80 million in 2004. Rent-A-Center's new $1.25 billion buyback plan could radically accelerate that trajectory.

Frankly, the move makes ample sense, as sales are growing just 5% annually, albeit withEBITDA (earnings before interest, taxation,depreciation andamortization ) margins of an impressively robust 30%. Rather than invest its profits in further growth initiatives that may or may not pay off, management instead prefers to radically shrink the share count.

Right now, consensus forecasts anticipate 2014earnings per share ( EPS ) of around $3.40. Yet a robust share buyback could hike that figure to $4 or even $5 in a few years, and if that happens, the current $35 share price looks like a great entry point.

Like Apple and Denny's, Rent-A-Center is taking advantage of very low interest rates: Its newly issued $250 million debtwill carry an interest rate of just 4.75%. Considering that this company's operating cash flowyield is around 15%, this debt-fueled buyback makes ample sense.

Risks to Consider: In the event that the economy weakens badly and current cash flow levels evaporate, then all three of these companies' buyback plans would look foolish.

Action to Take --> The era of low interest rates and high cash flow has changed the equation for many companies. It now makes sense for some companies to measure their returns on assets,equity andinvestments and if borrowing costs are well lower than these returns, then taking up debt to buy back stock could be one of the wisest moves to boost per-share profits and the share price.

It's also wise when companies buy back stock that is trading below tangiblebook value . As an example, I suggested last year that shares of banking giant Citigroup ( C ) might double if the company bought back stock at such a deep discount to book. Shares have almost reached my target price.

Unfortunately for Citigroup, regulators forced the bank to wait on buybacks untilcapital levels are stronger. In the table above, you'llnote that Citigroup has finally announced a billion-dollar buyback program. It would have been nice to proceed with the plan when shares were trading for half of book value, but as they are still less than 100% of book value, the buyback still makes sense.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing , Investing Ideas , Stocks
Referenced Stocks: C , EPS

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