Thursday, June 5, 2014

Watch Out for the Stock Buy-Back Taper

Back in the year 2000 I got a call from a broker wanting me to take a look at particular large cap financial stock.  The pitch was “the company has lagged its peer group, but it has announced a major share re-purchase program.”  I asked what the company plans were for growth.  Awkward silence was evident on the other end of the line.  I then said, “So you are asking me to buy-out certain shareholders who don’t want to own the company anymore because the management team is struggling to find ways to invest?”  Needless to say, I did not invest in the company.  But I did follow it.  Sure enough it did rise in the following months, only to be cut in half within the next 2 years.

I tell this story because I have always been wary of common stock buy-back plans.  Not because they are all bad.  Many companies have a disciplined approach of returning capital through this process rather than paying dividends.  However, when the buy-backs are not backed up by fundamental growth in the company, they turn into little more than the company entering the debt market to finance dividends, or worse, robbing from needed capital investment to maintain future cash flow.