A Bad Omen For Dell And Cisco Stockholders

Includes: CSCO, DELL
by: BubbleBustInvesting

Corporate buybacks are usually a strategy a publicly traded company deploys to boost the value of its stock. By reducing the number of outstanding shares, this strategy lowers the company's PE ratio—making its stock less expensive in comparison with its peers. But they do not always work, as has been the case with Dell Inc. (NASDAQ:DELL) and Cisco Systems (NASDAQ:CSCO). Though both companies have launched several stock buybacks in recent years (Dell announced another one two days ago), they failed to raise the value of their stock over the long run. By contrast, Apple (NASDAQ:AAPL) hasn't announced any buyback, and its stock has fared far better).

Here are some of the reasons:

1. A large number of shares outstanding (“share Inflation”). In the old good days (late 1990s) when both Dell’s and Cisco's stocks grew by leaps and bounds, both companies issued tons of shares. Now, even after several buybacks, Dell has close to 2 billion shares out, and Cisco close to 5.5 billion shares.

2. Both companies, together with the likes of EMC Corporation (EMC), Ciena Corporation (CIEN), and JDS Uniphase (JDSU), were labeled as “momentum” stocks. And as history confirms, once momentum is gone, no buyback program is sufficient to bring life to these stocks (Ciena and JDS Uniphase have fared far worse than Cisco and Dell).

3. Maturity. Both companies are no longer start-up companies with a few hundred employees that could grow their top line exponentially, but large mature corporations with thousands of employees that find it hard to grow.

4. Both companies failed to keep up with innovations, for different reasons. By and large, Dell’s innovation strategy is based on the application of a just-in-time system that has been for years used in the automobile industry into the assembling of computers—a non-proprietary innovation that can easily be replicated by the competition with limited potential for follow-up innovations. Dell’s model, further, has certain unique features that cannot be replicated overseas. In fact, the company has already failed to expand successfully in other countries, and the Chinese market won’t be an exception to the rule. Cisco's innovation strategy is based on strategic acquisitions, the purchase of smaller companies with breakthrough products, a strategy that isn’t sustainable, as owners of these smaller companies demand higher and higher premiums to compensate them for the risks they assume — Cisco end up paying top prices for Net Speed and Growth Networks acquired at the peak of the high-tech bubble. Strategic acquisition further end up being dilutive to existing stockholders when paid with the issuing of new stock — that's how Cisco ended up with 5.5 billion shares.

The bottom line: Stock buybacks isn’t a business strategy. It is an accounting strategy. It often reflects the inability of companies to deploy cash into the discovery and exploitation of new business opportunities—not a good omen for long-term investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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