Will’s Articles

Share Repurchases

WARNING:
Share Repurchases (“Stock Buybacks”)
Can be Dangerous to Your Money
(December 2004)

The current media and corporate enthusiasm over share repurchases (a.k.a. “Stock Buybacks”) can cost Shareowners a lot of money if they aren’t done right (See “ Stock Buybacks On Record Pace, A Bullish Indicator For Investors”, Investor’s Business Daily, November 12, 2004). There are no free lunches:

• As explained in Rich Shareowner, Poor Shareowner (Revised Edition) higher dividends and share repurchases are NOT bullish indicators for Shareowners. They represent cash paid out of the company that is not reinvested to grow the company. Like dividends, cash used to buy back company stock, returns money to Shareowners and simultaneously reduces the Enterprise Value and growth rate of the company. This means that the share price falls and regresses to a lower Enterprise Value (Net present value of cash flow).

• But in addition, BAD EXECUTION of the share repurchase by company management CAN ACTUALLY DESTROY Enterprise Value if the repurchases are done at a share price above the Enterprise Value... By using the PEG table, it is possible to estimate if management is creating (or destroying) Enterprise Value... If the PEG ratio calculated at the repurchase price is above the PEG ratio in the table for the company’s expected growth rate, then the repurchase is destroying Enterprise Value. If the repurchase price produces a PEG below the PEG ratio in the table, then it is creating Enterprise Value.

• P.S. If a company’s CEO, CFO and Board Members don’t know the company’s cost of capital or its Enterprise Value, then a share repurchase is like playing Russian roulette with the Shareowner’s money.

The PEG table is provided in Rich Shareowner, Poor Shareowner (Revised Edition) and Money Ain’t Free.