By David Sterman
If every era of investing can be characterized by a few select themes, then the current one can surely be noted by a stunning rise in corporate cash balances. Many companies have spent the past few years in cash-generating mode, yet they have seen few opportunities to invest that cash into acquisitions or stepped-up capital spending. As a result, with ever-rising cash balances, many of these firms are looking to re-acquire their own company stock.
Earlier this month, I profiled 10 mid-cap and large-cap companies that had recently announced plans for major stock buybacks.
Since then, as earnings season has progressed, a number of smaller firms have followed suit. A few dozen companies have announced new (or extended) buyback plans, and these 10 aim to acquire more than 10% of shares outstanding.
Not all buybacks make clear sense. In an ideal world, a company should be buying shares when the stock trades below book value, sports a very low forward multiple, or at least has come tumbling down from its 52-week high. So should you ignore stocks like Calgon Carbon (CCC), a provider of environmental remediation equipment, simply because it trades for nearly two times book and more than 15 times projected 2013 profits? Not necessarily.
I've written in the past that this company is poised for rising demand as air and water quality regulations tighten. Insiders, several of whom bought shares late in the summer when they traded above current levels, are surely bullish. But this isn't what I'd call a "no-brainer buyback stock."
The three "no-brainers" in this group: Tellabs (TLAB), CYS Investments (CYS) and Nacco Industries (NC), simply because they trade below book value. Any shares bought back at such discounted levels means they can create an even lower price/book ratio.
Let me explain. Let's say a company has $250 million in cash, book value of $1 billion and a market value of $900 million (or a 0.90 price/book value). Now, let's say the company spends $200 million on a buyback. Well, the book value falls to $800 million (as cash is reduced) and the market value falls to $700 million (as the share count falls and the share price stays constant). This stock would now trade for about 0.88 times book value (700/800).
The fact that Tellabs and Nacco are buying back shares after they have fallen more than 35% from the 52-week high is another plus. If you see a company buying back stock while it's right near its 52-week high, then it is tacitly admitting that "we have too much cash right now and lack creative ways of deploying it elsewhere."
I'd make an exception to this "below book" rule for Acacia Research (ACTG), which has anasset base that is likely understated on the balance sheet. Acacia acquires -- and then exploits -- a range of technology patents, securing multi-year licensing agreements in areas such as wireless communications.
Acacia's growing patent portfolio has fueled at least 30% top-line growth in 2009, 2010 and 2011. Thanks to a steady jump in patent acquisition activity during the past 18 months, coupled with an ongoing stream of new licensees, sales should rise more than 50% this year, to around $275 million. The high-margin nature of licensing revenue means earnings should more than double this year to above $1 a share, and above $1.25 a share in 2013.
Still, those growth forecasts are a bit lower than where they stood six months ago, as management concedes that some large licensing agreements are taking longer to negotiate. Even if some of those talks slip into 2013, and even if some talks end without bearing fruit, this is still shaping up to be a solid growth story. Consider that in the first nine months of 2012, Acacia has acquired 45 new patent portfolios for $214 million -- and still has more than $400 million in net cash in the bank. If shares remain depressed after the current buyback is completed, you can look for a possible additional buyback program to take place.
Risks to Consider: Buybacks done at market highs can be a waste of shareholder's money, so if the market tumbles a lot lower from here, then these current buyback programs will have proved to be poorly-timed.
The silver lining of a falling market is that buyback plans can defend shares with buying (when sellers are otherwise dominating the trading tape) and can also sop up even more shares if the stock price falls. Each of these companies stands to cut the share count (and boost earnings per share) by at least 10%, and a falling stock price would just magnify that leverage. Use this list as a starting point to find a good buying opportunity. But don't be simply looking at buyback announcements in a vacuum. Take note of the relative valuations of the company in question -- especially to see how close to book value it trades -- and assess the financial strength of the company in question. If the buyback will be done out of cash flow and not from cash balances, then the company's financial strength could come into question in an economic downturn.
Additional disclosure: StreetAuthority LLC owns shares of CCC in one or more of its “real money” portfolios.