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  1. Home
  2. / Investing
  3. / Financial Services

The Yeas and Nays of Stock Buybacks

Such actions often are a dubious use of cash.
By TIM MELVIN Feb 19, 2014 | 04:00 PM EST
Stocks quotes in this article: AIG, HTBI, ESSA, HGG

I am not a huge fan of stock buybacks as a rule. I see them done too often by management in an attempt to appear shareholder friendly but they repurchase shares at too high a price.

If you have excess cash and no clue what to do with it, most of the time I would prefer you just sent me a check. I am sure I can find better uses for the money than buying back stock at 25x earnings and 5x book value. It is also a favorite tool of earning manipulators who use buybacks to massage the number into Wall Street's estimated range. Buying back stock with shareholder money to cover the dilution if excessive option grants is also a dubious use of cash. I would be much happier 90% of the time if companies just paid a dividend.

There is always an exception to every rule. If you are actively buying back stock below asset value, then you are actually increasing my holdings in an undervalued asset. That's usually a good thing. That's pretty much the only time I can get excited about buybacks, but that's pretty consistent with my deep-value approach to the markets. If I like the idea of buying your stock below book value, then using shareholder cash to join me in buying is okay by me.

It is a pretty simple task to sit down and run a list of companies whose shares trade below book value and who are buying back stock. The largest company that makes the list is the poster child of the financial crisis American International Group (AIG). The company continues to work its way down the comeback trail. Although it is one of the most widely-owned stocks by hedge funds, the buying has still only pushed the stock up to about 75% of book value.

The company resumed buybacks in the third quarter and just announced a new $1 billion repurchase program. AIG is on my buy in a market collapse list of larger companies and the buyback should help put a floor in the stock.

HH Gregg (HGG) is another company whose shares trade below book value that has been buying back stock. Like most other electronic and appliance retailers, the stock has been hurt by the poor fourth quarter results as consumers either purchased stuff on line or just simply didn't buy this past holiday season. The stock currently trades around 88% of book value and management has been aggressive about buying back shares. In the fourth quarter they spent more than $15 million to buy shares and only have about $10 million left under the $50 million buyback program instituted last May.

This is a battle of buyback vs. short sellers as more than 24% of the float of this company is sold short right now. If they make any positive announcements in the near future, this stock could see a strong pop as the shorts rush for cover.

As a big believer in the Trade of the Decade in small bank stocks I am happy to see several of my small bank holdings on the list of cheap buybacks. ESSA Bancorp (ESSA) has been a favorite stock of mine for some time now and the shares are still cheap at just 84% of book value. Fully-diluted shares outstanding declined from 12 million to just 10.9 million in the past year as management used excess capital to repurchase its own shares at bargain levels.

HomeTrust Bancshares (HTBI) just announced its third consecutive buyback program since becoming a public company back in 2012. They will be buying back up to 5% of the outstanding shares of the banks. The Ashville, N. C. - based bank is currently trading at just 87% of book value so it appears management tis spending its shareholders money wisely.

The vast majority of all buybacks are a waste of shareholder money. Buying shares at inflated levels is not in the best interest of the real owners of the company and neither is using buybacks to massage earnings numbers. Buying stock below book value, however, can actually increase shareholder value and is a solid use of corporate funds.

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At the time of publication Melvin was long ESSA.

TAGS: Investing | U.S. Equity | Financial Services | Stocks

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