The Bed Bath & Beyond Stock Buyback Should Make You Richer

| About: Bed Bath (BBBY)

For a company's stock buyback program to catch my attention, there are three elements that I look for:

1. First, the company should have a history of actually reducing the share count when it executes a stock buyback.

2. Secondly, the company should be executing its stock buyback during a time when the stock is actually undervalued so it can create shareholder wealth.

3. And lastly, the share buyback amount should be meaningful enough that it actually reduces the share count in a way that could create a pop in wealth (for me, I look for a buyback program that has the potential to reduce the total shares outstanding by at least 7%).

The pursuit of companies that meet those three factors takes me to one of the more intriguing opportunities in today's investment landscape: Bed Bath, and Beyond (NASDAQ:BBBY).

Looking at the first element, it is clear that Bed Bath, and Beyond means business when it comes to share buybacks. Although this company does not pay a dividend, it has been a relentless net purchaser of its own shares throughout the past decade. In 2003, the company had 300 million shares outstanding. Today, the company has 226 million shares outstanding. That is a nice 30% decrease in the total share count over the past decade, which actually proves that long-term investors have a greater per share claim to the firm's profits than they did ten years ago.

Moving on to the second element, I like to see buybacks when the stock is undervalued, because that is the only way to create wealth by using the buyback structure. The company earned $4.60 (adjusting for one-time items) in 2012. At a current price of $62 per share, that works out to a normalized P/E ratio of 13.5. By using the past decade's valuation as a measuring tool, the stock is cheap. The first few years of the 2000s saw investors value Bed Bath, and Beyond with a P/E ratio in the 30s. It moved down to the upper teens during the 2004-2008 period before falling to 14x earnings during the financial crisis. By these metrics, it would appear that the stock's current valuation constitutes an acceptable time to conduct a buyback.

I should note, however, that when investors see a drastic decline in P/E ratio that is not consistent with the rest of the market (Bed, Bath, and Beyond has fallen from 30x earnings to 14x earnings over the past ten years), it can be worthwhile examining whether the business model has been impaired in such a way that warrants a lower P/E multiple on the earnings (or it could be due to a perceived drop in future growth prospects). In this case, it seems that the P/E multiple has declined for two reasons: Bed Bath, and Beyond has a tough time of improving same store sales (most of its growth comes from opening new ones). And secondly, the company has trouble competing with Amazon (NASDAQ:AMZN). If you visit, and then spend a few minutes visiting the website, you'll see why Wall Street analysts are worried that customers will make their online purchases of in-home goods on Amazon instead of the Bed Bath, and Beyond website.

At the present time, I do not believe these concerns are substantial enough to deter investment in Bed Bath, and Beyond for two reasons. First of all, the housing market has been terrible over the past five years. If there is a moderate improvement in home purchases over the coming years, the demand for Bed Bath, and Beyond products should increase by double digits. And secondly, despite the tough environment of the past five years, the company has managed to grow earnings by 10.5% annually over the past five years. From 2008 through the present, the company has managed to increase earnings every year, and as someone that places strong emphasis on a company's performance during economic downturns, I find this fact especially impressive for a specialty retail company.

And the last fact I like to look for in a stock buyback is this: an amount that will actually move the needle and meaningfully reduce the share count. The company is gearing up to spend $2.5 billion retiring shares after the remaining $200 million on its current buyback program runs out. Essentially, we may be looking at $2.7 billion over the next two years. The company is currently valued at $14 billion, indicating that the current and new buyback program represent 19% of the share count if executed optimally. This is a buyback amount that can create material wealth for shareholders, assuming that the buyback gets carried out at the prevailing market prices.

Bed Bath, and Beyond is admittedly not a stock for everyone. It's fallen by 50% from peak to trough on three different occasions since 2001. That may be too much volatility for some investors that do not like large fluctuations in their net worth. Additionally, this company does not pay a dividend, and instead chooses to create wealth through the buyback program. That may deter some from investment. However, for an investor with an eye on the potential for capital gains, it seems that Bed Bath, and Beyond offers an intriguing opportunity. The company has reduced the share count every year since 2003, taking about a third of the shares off the market over that time. Likewise, the company is in the interesting position of trading at one of its lowest P/E ratios in the past decade while simultaneously seeming poised to grow earnings by a double digit rate into the future (Wall Street estimates 14.5%). And lastly, the amount of the buyback is meaningful, as the company could potentially take just shy of 20% of its share count off the market in the coming two years. That seems like the recipe for a successful buyback program.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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