Stock Buybacks on a Comeback Trail

Includes: ABC, AMGN, PEP
by: John P. Reese

While the U.S. government's balance sheet has been getting the lion's share of the attention lately, there's another American balance sheet that deserves investors' attention: corporate America's.

When the financial crisis hit in 2008, many U.S. firms began planning for the worst. And by cutting costs and streamlining operations to prepare for a potential depression, they put themselves in very good position when the economy began to rebound. According to one recent study by Credit Suisse, U.S. companies collectively have all-time-high levels of cash as a percentage of market cap and aggregate free cash flow yield.

Companies won't sit on that cash forever, especially not with money market funds yielding so little. Many have already started putting it to use, and one way they're doing so is by buying back their own shares -- a practice that had become extremely unpopular in 2008 and 2009. S&P 500 companies slashed spending on repurchases by more than 85% from peak to trough, SmartMoney's Jack Hough recently noted.

That's changed in 2010. U.S. firms have already announced plans to make more than $150 billion in stock repurchases, up from less than $20 billion in the same period in 2009, Time magazine recently reported (citing data from Dealogic).

Share repurchases can have some very beneficial impacts for shareholders. One of the biggest is that taking shares off the market spreads a firm's earnings over a smaller number of shares, giving shareholders a bigger cut of earnings for each share they hold. And, Hough notes, there's reason to believe companies may be particularly keen on using cash for share repurchases going forward because of tax law changes: The expiration of the Bush tax cuts means that next year, dividends should be subject to normal income tax rates -- not the current 15% maximum level.

That's not to say dividends are going to fall by the wayside -- with more than a trillion dollars in cash on non-financial firms' balance sheets, there should be plenty of cash to go into both dividend payouts and share repurchases. But given the dramatic cutbacks companies made on share repurchases in 2008 and 2009 -- and the significant rebound we've seen in 2010 -- I thought it would be a good time to check for stocks that have been buying back shares and get approval from my Guru Strategies -- each of which is based on the approach of a different investing great. I found several firms that fit the bill; here's a look at some of the best of the bunch.

PepsiCo (NYSE:PEP): In March, the New York State-based beverage and snack giant announced a $15 billion plan to buy back shares that will run through June 2013. The firm, which has a $99 billion market cap, gets approval from both my Warren Buffett- and James O'Shaughnessy-based approaches.

The Buffett model looks for firms with lengthy histories of earnings growth, manageable debt, and high returns on equity (a sign of the "durable competitive advantage" Buffett is known to seek). Pepsi delivers. It has upped EPS in 7 of the past 10 years, with all the dips being relatively minor; it has enough annual earning that it could pay off all its debt in a little over three years if it needed to; and its 10-year average ROE is 32.0%, more than doubling my model's 15% target.

My Buffett model also gives companies bonus points if their number of shares outstanding has fallen over the past five years, because that's a sign that management may be making buybacks that will enhance shareholder value. Pepsi's shares outstanding have fallen from 1.66 billion to 1.61 billion in that period, a good sign.

My O'Shaughnessy value model also likes Pepsi. A few reasons: the firm's size, strong $4.89 in cash flow per share, and solid 3.1% dividend yield.

Amgen, Inc. (NASDAQ:AMGN): Late last year, this California-based biotech firm announced it was upping its share buyback plan by $5 billion (in addition to the $1.2 billion it had left under a previous program). The company, which makes medicines that target a myriad of diseases, including various types of cancer, gets high marks from the strategy I base on the writings of Peter Lynch. Its 17.8% long-term earnings per share growth rate (I use an average of the three-, four-, and five-year EPS growth rates) and high sales (almost $15 billion over the past year) make it a "stalwart" according to the Lynch approach -- the kind of large, steady firm that Lynch found offered protection during downturns or recessions.

To find growth stocks selling on the cheap, Lynch famously used the P/E/Growth ratio; P/E/Gs below 1.0 are acceptable to my Lynch-based model, with those below 0.5 the best case. When we divide Amgen's 11.1 P/E by its growth rate, we get a P/E/G of 0.62 -- a sign that it's a bargain. The Lynch-based model also likes conservatively financed firms, and Amgen's moderate 52% debt/equity ratio passes the test.

AmerisourceBergen (NYSE:ABC): This Pennsylvania-based pharmaceutical services firm initiated a new $500 million share buyback program last fall, and it expects to spend about $350 million repurchasing shares this year. The firm, which handles about 20% of the pharmaceuticals sold and distributed throughout the U.S., currently has about 287 million shares outstanding, down from about 312 million the previous year.

Bergen ($8.7 billion market cap) gets approval from the growth approach I base on the writings of James O'Shaughnessy. This strategy looks for stocks that have upped EPS in each year of the past five-year period, which Bergen has done. It also likes the stock's strong relative strength of 86 (a sign the market is embracing it), and its very low 0.12 price/sales ratio (a sign it hasn't gotten too pricey).

My Lynch-based model also likes Bergen, which it considers another "stalwart". For stalwarts, Lynch adjusted the "G" portion of the P/E/G to include dividend yield. While Amgen doesn't offer a dividend, Bergen has a small one, and its yield-adjusted P/E/G comes in at a solid 0.83. The firm also has a reasonable debt/equity ratio of 48%, another reason the Lynch approach likes it.

Disclosure: I'm long PEP and ABC.