Are Company Stock Buybacks Good News?

We’re seeing a greater number of companies buying back their own shares than we have in a while. Prior to the financial meltdown, company buybacks were the biggest net purchasers of stock shares. During the crisis that began in 2008, companies pared back to conserve cash. Now, they’re in buying mode again.

Two weeks ago, PepsiCo (PEP) announced that it would buy around $15 billion worth of its shares in the next three years, and $4.4 billion worth just this year. That’s the biggest buyback program announced since the meltdown disconnected the buy button at most companies. In all of 2009, companies spent just $137 billion on share buybacks. So far this year, they’ve already spent $70 billion.

Most analysts seeing that call it a bullish sign, but it isn’t always. There are two ways that companies pass along excess cash to shareholders: dividends and cash buybacks. The two are combined into the “shareholder yield” measure mentioned on page 102 of the 2010 edition of my stock book, because the method companies tend to choose changes in different environments. Either way, however, the goal is to give back to shareholders cash that isn’t needed elsewhere in company operations.

Not needed elsewhere? That doesn’t sound optimistic. It smacks of a lack of growth opportunities, which is why dividends are associated with mature companies. You’ll never see an upstart paying out cash as dividends. It would rather buy more supplies, build new plants, hire new people, expand into new regions, develop new products, and so on. An established company just keeps the machinery humming at a predictable rate, and pays a steady yield.

Thus, how good is the news if companies have concluded that the economic environment is bleak enough that giving back to shareholders is the best use of excess cash? Not very. It hints at more pessimism than optimism. On this subject, Citigroup’s Carsten Stendevad told the Economist two weeks ago: “Many firms have emerged from the crisis with record levels of cash on hand, yet see few organic growth opportunities.”

That notion was seconded in a client note sent yesterday morning by Gluskin Sheff’s David Rosenberg, from which:

The vast majority of companies are buying back their stock to avoid the dilutive effects of expiring stock options — of the 214 companies that did a buyback in Q4, only 50 resulted in share count reductions (see page B2 of the weekend WSJ). Moreover, it really says something about the widespread excess capacity in the economy and poor perceived rates of return on new investments that companies would opt to deploy cash for buyback strategies at this presumed early stage of the business expansion.

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