Companies that have excess cash on their balance sheets or that have recently borrowed money have a number of things they can do with that cash. The company could plunge it back into research and development, use it for promotional activity, or save it for countless other operational needs. However, there is another option for spending that cash, and that's for the company to buy back its own stock, and when a company engages in a little repurchasing, the investment community should pay close attention. (To learn more, read A Breakdown Of Stock Buybacks.)
What Makes Buybacks So Special?
Right off the bat, an active share repurchase program says a great deal about where a company's management and board of directors think it is heading. Why else would a company spend millions or even billions of dollars repurchasing its own equity in the open market unless it thought doing so was a wise investment or that its shares were being undervalued by the marketplace?
The mangers know the company better than any one else, and so if they decide that buying back shares is the possible use of the company's excess cash, investors should seriously examine the company's prospects and consider investing some of their own excess cash into the stock.
Coattailing Stock Buybacks Can Be Profitable
There is no guarantee that when a company repurchases its stock that the value of its shares will ultimately climb. After all, in the stock market, anything can happen. However, there are times when mimicking a company that has repurchased its shares can prove to be an extremely profitable venture.
A great example is found in Sears (Nasdaq:SHLD). Back in the second quarter of 2003, the retail stalwart spent about $1 billion to repurchase its own stock from the open market. What happened next? Investors that were smart enough to copy Sears' move and hold on to their shares made some serious money. The stock has shot up from the $15 range in June of 2004 to trade at more than $80 by June 2008, producing over 400% of share price appreciation during that time.
All Aboard The Buyback Express
As investors can take away an important lesson from these two examples: coattailing a corporate stock buyback can pay off handsomely if you pick the right company. Here's a shortlist of companies that have bought back sizable amounts of their own stock, and thus could end up producing returns that rival the likes of Sears and McDonald's.
| Company |
Market Cap |
Return (TTM) |
Autozone
(NYSE:AZO) |
$7.7B |
-8% |
BJ's Wholesale Club
(NYSE:BJ) |
$2.5B |
12% |
Check Point
Software
(Nasdaq:CHKP) |
$5.2B |
3% |
Herbalife
(NYSE:HLF) |
$2.6B |
6% |
Tyco
(NYSE:TYC) |
$19.7B |
-16% |
Zale Corporation
(NYSE:ZLC) |
$713M |
-11% |
| Data as of market close July 17, 2008. |
Any of the above-mentioned companies have solid potential for growth over the long haul. Each is among the leaders in its industry and each has impressive brand equity and a broad footprint. That said, there is one company in particular that piques my interest and that I think is especially worthy of follow-up research for investors looking to coattail a share buyback program.
Buyback Artist BJ's Wholesale
With the economy slowing, consumers are looking to pinch pennies wherever they can. And frankly, I think this plays right into wholesale clubs' hands. BJ's Wholesale sells everything from jewelry to televisions to meats, and generally at competitive prices. This will allow customers to get a lot of their shopping done under one roof.
In Q1, BJ's Wholesale Club spent $30 million to buy back about 925,000 shares of its stock. Very simply, I see that as a bullish sign. This was just the beginning of the good news for BJ's, however. In its first quarter ended May 3, BJ's earned $17.2 million, or 29 cents per share. That's well north of the $13.7 million, or 21 cents per share, it earned in the comparable period last year. It was also penny ahead of expectations, which drew a few eyeballs. These numbers come from solid revenue growth (roughly $2.31 billion from $2.06 billion in the same period last year), and comparable club sales growth of 9.6%.
Another thing that I like is that management raised the bar on the earnings front. In conjunction with its Q1 numbers, management expects the company to earn $2.04-2.14 per share in fiscal '08. This translates to an increase of 6 cents versus prior guidance of $1.98-2.08 per diluted share. (Find out more on how company guidance affects stock price in Can Earnings Guidance Accurately Predict The Future?)
My biggest concern is that I am always wary of buying stocks near their 52-week highs, and BJ's is trading right near its annual high. However, because its prospects for future growth appear solid to me, I do think the stock is currently worth nibbling.
The Bottom Line
The stock market is full of examples where companies have bought up boat loads of their own stock, and then investors watched as the share price rose steadily in the years to come.
When you see a company that is buying its own stock, it is usually a good idea to do a little research to see if the stock is truly undervalued. As the investors who bought Sears in 2003 and were sitting on 400% returns by 2008 have shown, there is a lot of profit to be had by simply mimicking the share buyback programs of well-run companies.
