When industry veterans are asked to join a company's board of
directors, they are expected to stick around for many years. That
gives them the accumulated knowledge of a company's operations,
industry positioning and economic sensitivity to help guide
forward-looking investment planning decisions. And right now, many
of these directors are advising company management to direct funds
into one key area: stock buybacks.
These directors know that their companies are weathering the
current tough
economy
in decent -- if not robust -- shape, and they know that even better
days lie ahead as the economy improves.
So as these companies keep piling up cash quarter after quarter,
their own stock is turning out to be a solid investment. In recent
quarters, I've noticed an explosion in stock buyback activity, and
the current quarter is no exception.
Here's a look at all of the companies that have announced new (or
extended existing) buyback plans of at least $500 million thus far
in the second quarter.
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When it comes to judging buyback stocks, there are two things to
keep in mind. First, the buyback should equate to a hefty portion
of the existing share count in order to meaningfully shrink the
denominator part of the
EPS
equation.
Visa's (NYSE:
V
)
$1 billion buyback may seem impressive, but it represents just 1%
of company stock.
Second, buybacks should be the response to low valuations and
not simply because cash is lying around. The S&P 500 currently
trades for around 12 times projected 2013 profits, and you want to
focus on stocks that have a lower
multiple
than the broader
market
. With those factors in place, the list of buyback candidates for
further research can be narrowed down to these six companies.
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These stocks all sport low
multiples
because they are either in an operational slump at the moment, or
they operate in a sector that is cyclically out of favor. For
example, insurance firm
Unum (NYSE:
UNM
)
may appear to have a very low multiple, but so do other insurers
such as
Prudential Financial (NYSE:
PRU
)
,
Met Life (NYSE:
MET
)
and
Hartford Financial (NYSE:
HIG
)
. So
shares
are unlikely to rally until the whole sector does. At least Unum is
wise enough to buy back shares while the company's stock is valued
at roughly two-thirds of
book value
. Any buybacks done at "below book" prices are simply a
no-brainer.
Ideally, you want to see buybacks done at multi-year lows. So
the fact that shares of railroad freight transporter
Norfolk Southern (NYSE:
NSC
)
is buying back stock while it's near a five-year high can be a bit
off-putting. Instead, if you're looking for a better investment in
this sector, my colleague Mike Vodicka recommended an intriguing
stock
in this article
.
Thank you Mr. Einhorn
By a perverse logic, noted
Wall Street
short-seller David Einhorn has done nutritional supplement firm
Herbalife (NYSE:
HLF
)
a big favor. Einhorn gently suggested in late April that the
company was boosting sales by counting revenue when its network of
third-party re-sellers were ordering from the company -- and not
end-users. He asked pointed questions on the first quarter
conference
call
that greatly spooked investors.
It's too soon to know if his concerns are off the mark, but
recently-released second-quarter results didn't show any signs of
distress. In fact, Herbalife delivered
earnings
of $1.10 per share that were roughly 10% ahead of consensus
forecasts and roughly 25% higher than a year ago. And Einhorn was
noticeably absent from the recent conference call. Still, the
damage has been done, and shares remain well below levels seen in
the early spring.
The resulting selloff will enable Herbalife to get even more
bang for its buck with a just-announced $1 billion buyback plan
that could shrink the share count by one-sixth. Presumably,
management wouldn't be foolish enough to commit such a large sum of
money if end-user sales were indeed as weak as Einhorn was
suggesting.
Risks to Consider:
Buybacks can turn out to be a big mistake if the economy slumps
badly and the companies later realize that it would have been nice
to have that cash lying around for other purposes.
Action to Take -->
One of the biggest reasons to buy stocks of companies that are
engaged in buybacks is the defensive nature of the strategy.
Companies that are buying back stock can step in and provide share
price support when most other stocks are only seeing selling
pressure. If you can find stock buybacks being done at below-market
multiples and they are consuming a large portion of the share
count, then you may have just found your next investment.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of V in one or more if its "real money" portfolios.