Knucklehead Buybacks: How To Find Smart Ones

by: YCharts

By Carla Fried

The buyback machine continues to rumble on. Liberty Global (NASDAQ:LBTYA) just announced a $3.5 billion buyback plan over the next two years and Prudential Financial (NYSE:PRU) says it plans to spend up to $1 billion on share repurchases. Granted, 10 figures is 10 figures, but $1 billion is mere chicken feed compared to Wal-Mart's (NYSE:WMT) announcement last week that it will spend $15 billion to buy back shares. And that news came on the heels of earlier 2013 mega buyback announcements, including Apple's (NASDAQ:AAPL) intention to spend $60 billion over the next few years on buybacks, the $17 billion authorized by Home Depot (NYSE:HD) for buybacks, the $15 billion Merck (NYSE:MRK) plans to spend on repurchases, and the mere $5 billion announcement from IBM (NYSE:IBM).

S&P Capital IQ recently noted that we're on pace to have more than 90 stock buyback announcements this year valued at $1 billion or more, making it the most active year since 2007 for deep pocket repurchases.

The mere mention of 2007 is cause for concern. Corporate boards rubber-stamped record buybacks that year -- nearly $590 billion according to S&P Dow Jones Indices -- at what was an epic market high. Not exactly in tune with the buy-low concept.

Among the big deals announced this year, Home Depot's decision sticks out as the biggest head scratcher. The 130% gain in the stock price since its early 2011 lows, as seen in a stock chart, has been accompanied by a steep rise in the stock's valuation.

HD Chart
(Click to enlarge)

HD data by YCharts

Forward and trailing PE ratio north of 21, while the market is hovering around 15 seems doesn't scream great value play; the trailing PE ratio is at a 10-year peak.

By comparison, Wal-Mart's forward and trailing PE ratios are below 15.

(YCharts' coverage includes a special focus on stock buybacks: The perverse incentives that cause companies to buy when their stock is expensive; identifying which companies actually reduce shares outstanding via buybacks; what may be the dumbest of recent buyback sprees; a look at companies that do buybacks right.)

To be sure, the buyback strategy has been getting plenty of attention of late. The PowerShares Buyback Achievers ETF (NASDAQ:PKW), wallowing in relative obscurity a year ago with just $165 million in assets, has bulked up to more than $630 million today. But as Home Depot and Wal-Mart show, not all buybacks are created equal in terms of their timing. That illustrates the value of doing your own financial research to determine if a buyback makes sense, or if it's looking like a dubious use of capital.

The YCharts Stock Screener tool provides an easy way to quickly get a bead on the buyback poseurs looking to goose earnings no matter how pricey the stock is today. After selecting the S&P 500 as a starting point, Platinum subscribers can find the Net Common Equity Issued metric under the Cash Flow category. Choosing Trailing 12 months as your time frame and then ranking them in ascending order (click on the column header in the list to sort any column) shows that Exxon Mobil (NYSE:XOM) with a -$20.8 billion is atop the list. The negative is confirmation that the company was buying back shares; a positive number means the shares outstanding was increasing.

Moving the slider on net common equity issued to -1B for the max cuts the list down to just 93 companies with significant repurchases.

From there it's easy to layer in a few valuation metrics to get a quick look at which companies are buying low vs. high. Exxon Mobil, the biggest net repurchaser of shares passes the valuation test, with PE ratios below 12. IBM, another aggressive long-term repurchaser also trades at below-market multiples.

Sorting the list in descending order of forward PE ratios exposes stocks that sure look pricey and require further financial research. Bristol-Myers Squibb (NYSE:BMY) spent more than $2.3 billion on repurchases over the past year, managing to push down its shares outstanding by 2.2%. But a forward PE ratio above 25 is a warning signal. Sure enough, while the stock has rallied of late, profits haven't.

MasterCard also looks pricey as both its PE ratios are above 20. But digging around a bit a 5-year chart shows that the stock has a habit of trading at an above-market valuation, and that 20+ hasn't really budged much while the stock has soared.

Moreover, as this chart shows, MasterCard's (NYSE:MA) buybacks weren't implemented to obscure weak earnings. As if.

(Click to enlarge)

MA EBITDA TTM data by YCharts

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. I have no business relationship with any company whose stock is mentioned in this article.

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