Corporate stock buybacks are a popular strategy among publicly traded companies to boost the value of their stock. By reducing the number of outstanding shares, this strategy decreases the company's PE ratio—making its stock less expensive in comparison with its peers. But does this really work? Do they enhance or destroy shareholder value?
A recently published Wall Street Journal article argues that buybacks are “buying” trouble, destroying shareholder value—though they are exceptions to the rule. Buyback’s, for instance, have destroyed value for Cisco Systems (CSCO) Dell Computer (DELL), Hewlett Packard (HPQ), and Bank of America (BAC), but have enhanced shareholder value for International Business Machine (IBM), McDonald’s (MCD), Coca-Cola (KO), Chevron (CVX), and Caterpillar (CAT). What makes the difference?
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Answer: The economic fundamentals of the companies that pursue them. Buy-bucks pursued by companies with strong economic fundamentals enhance shareholder fundamentals, as they do not defer cash away from growth opportunities; as has been the case with McDonald’s Coca-Cola, Chevron, and Caterpillar.
By contrast, buybacks pursued by companies with weak economic fundamentals destroy shareholder value, as they defer cash from growth opportunities; as has been the case with Dell Inc. and Cisco Systems. Both companies have failed to deploy cash to maintain high sales growth, disappointing investors. The two companies further, together with the likes of EMC Corporation (EMC), Ciena Corporation (CIEN), and JDS Uniphase (JDSU), have been 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).
The bottom line: Stock buybacks may enhance or destroy shareholder value, depending on the economic fundamentals of the companies pursuing them; they do enhance shareholder value for companies with strong fundamentals, but destroy shareholder value for companies with weak fundamentals.