Warning: That Share Buyback Might Be Hiding This Strategy

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This is a great time to be running a public company.

The surging stock market has created billions in wealth for the leading officers and directors, as previously granted stock options are now deep in the money. Of course, companies don't like to publicize the fact that executives are reaping huge gains while leading the share count to bloat. Add all of their shares into the current base of stock, and investors would really be up in arms.

That's why many companies offset these lush stock options programs with share buybacks. As long as they are able to keep the share count flat, investors are unlikely to grumble too loudly. But it also means that you should be skeptical when you hear about buyback announcements.

Case in point: Regional bank KeyCorp (NYSE: KEY ) , which conducted a pair of buyback plans over the past two years totaling nearly $800 million. That equated to nearly 5% of shares outstanding. But in a study conducted by Deutsch Bank, KeyCorp actually shrank its share count by just 1%. In effect, most of that $800 million went toward enriching executives, not shareholders.

That's why it's crucial to track companies to see if they are really moving the needle. The good news: Some companies' buyback plans have really benefited investors. Home Depot's (NYSE: HD ) , share count, for example, has fallen from 2.2 billion in 2005 to a recent 1.4 billion. That 36% drop in shares outstanding has a direct and salutary benefit on earnings per share ( EPS ). Cisco Systems (Nasdaq: CSCO ) is another fine example: Its share count has dropped from 6.6 billion in 2005 to a recent 5.4 billion.

And these firms have company. Here are three other companies that are not simply looking to offset stock option grants with buybacks but are developing a proven track record of share count shrinkage.

1. Macy's (NYSE: M )
A tough environment for consumer spending has certainly been felt at this department store chain. Annual sales are growing just 1% to 2%, and even that's solely due to price increases. Still, Macy's is in the midst of a powerful upturn in earnings per share. EPS rose from around $2 a share in fiscal 2011 to more than $3 a share in fiscal 2013, and analysts see that figure exceeding $4 a share in the fiscal year that begins next February.

Credit goes to a fast-shrinking share count. Shares outstanding had ballooned to 548 million by fiscal 2007, but steadily dropped to 430 million in fiscal 2012. Since then, this trend appears to be accelerating.

Macy's falling share count (millions)

2. Marathon Petroleum (NYSE: MPC )
I'm a huge fan of refinery stocks, as I recently noted , thanks to very high potential dividend yields at the industry's niche MLPs (master limited partnerships) and impressive buyback programs among the big, traditional refiners such as Marathon Petroleum.

Marathon's share count has fallen from 364 million in the third quarter of 2011 to 340 million a year later and a recent 311 million. That's a 15% reduction in shares outstanding in just two years. And Marathon appears to be stepping on the gas. In September, this refiner added $2 billion to an existing buyback plan that still had $1.3 billion remaining. That should shrink the share count by another 10% to 12%.

The falling share count has softened the blow of a compression in oil refinery margins. Yet analysts expect those margins to widen again in 2014, meaning Marathon should post higher operating income and have a smaller share count. The current forecast of a 20% hike in 2014 EPS (to around $9.20 a share) is starting to look far too conservative.

3. Motorola Solutions (NYSE: MSI )
It's been nearly a century since this company developed the first in-car radio. And despite a 2011 sale of the company's telecom business to Google (Nasdaq: GOOG ) , this company is still a leader in wireless communications equipment. It's a sturdy niche, thanks to recurring revenues from federal, state and local governments, but top-line growth has become anemic.

Still, a fast-shrinking share count has generated impressive EPS growth. Over the past eight quarters, shares outstanding have fallen from 335 million to 262 million. Combined with cost cuts that have boosted profit margins, MSI now can deliver more than $4 in annual EPS, up from $1 to $2 in annual EPS just a few years ago.

Risks to Consider: As long as the market keeps on rising, insiders at many companies will keep cashing in their stock options, which will offset the impact of share buybacks.

Action to Take --> As more companies pursue massive and ongoing buyback programs, investors are not as concerned if top-line growth is anemic. As long as buybacks keep shrinking the share count by a considerable amount, then robust EPS growth can help boost stock prices yet higher. If you bought a stock on the basis of a seemingly impressive buyback program, then it pays to monitor the diluted share count from quarter to quarter. If the share count isn't falling, then management isn't sufficiently looking out for your interests.



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

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Stocks

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