In last weekend's Wall Street Journal, the always pragmatic and helpful Jason Zweig wrote a nice piece on stock buybacks. He pointed out that in 2013, corporations repurchased $567 billion of their own stock. That was a more than 20% increase over 2012, as managers found themselves with excess cash and nowhere to spend it in an economy that offers limited growth opportunities.
Since 2005, public companies in the U.S. have repurchased more $4.21 trillion of stock. While buying back your stock when it is cheap makes a great deal of sense and can be an important driver of shareholder value, many companies are buying regardless of value, and that can be a long-run negative. Just ask J.C. Penney (JCP) shareholders how buying back overpriced shares can work out.
Corporate boards have not shown the same sensitivity to value when spending shareholder cash as they have when spending their own money. Insider purchases for their own accounts have had a historical bias for buying near new lows and low multiples of earnings and book value. However, they tend to buy back more stock for the corporate account as markets move higher and valuation becomes stretched, according to the article. In fact, the all-time high for share buybacks was in 2007, just before it all came apart at the seams.
I have long been a critic of overpriced stock buybacks. While a pricey buyback may temporarily pump up earnings, spending the shareholders' money to buy stocks at high multiples of asset value and offering paltry earnings yields is an incredibly inefficient use of our money. If you really cannot find a way to invest excess cash, then send it back to me as a dividend before you spend it on a stock at 25x earnings, and I will decide what to do with what is actually my money as a shareholder.
I thought it might be interesting to run some screens to see which companies are the worst offenders when it comes to stock buybacks at high levels. There are some interesting names on the list, and these are stocks that should be avoided, as they are overvalued, and the companies are using shareholder cash in an inefficient fashion.
I avoid home-improvement stores like the plague, but my wife loves Home Depot (HD) and Lowe's (LOW). While I understand the story here, given the improvements in the housing market and consumers feeling comfortable enough to spend money to fix up their homes, I am not sure I buy it. Even if I did, both stocks are on the pricey side and are best avoided by investors -- and that includes the corporate treasurer.
Home Depot currently fetches 21x earnings and 8x book value. Using the Graham number, the stock is more than 100% overvalued at this level. Lowe's is trading at 22x earnings and 4x book value. The Graham number is just about 60% of the current price. Neither stock is cheap, but both companies have been aggressively buying back stock. If you do not need the cash for expansion or to fund new growth, please just send me the money back.
I would have thought that Tim Hortons (THI) had sufficient growth opportunities that it would not have to buy back stock at 21x earnings and 11x book value. However, it just announced a new buyback plan for an additional 5% of the company. While I applaud the 23% dividend increase, I would prefer that the company take the $440 million for the buyback plan and use it to double the dividend or open new stores. I cannot find any set of numbers that would make the shares look cheap. Even the optimistically useless price/earnings-to-growth (PEG) ratio that some growth types favor is over 22, and the shares fetch 4x the Graham number. There are better uses of shareholder cash than buying back stock at this level.
Papa John's (PZZA) makes a pretty good pizza and is a well-run company. However, there has to be a better use of corporate cash then buying back stock at more than 30x earnings and 16x book value. The people who authorized the buyback seem to think so, as they have been exercising options and selling the shares in the open market. Since the stock is at 4x the Graham number and has a PEG ratio of more than 2, there is just no compelling argument that it is cheap enough to buy. The company just authorized another $100 million buyback and now has a total of $225 million authorized. If you really do not need the money, please just send me the $5 a share as a special dividend.
These four companies are just a few examples of overpriced buybacks. Corporations are not hiring, and there do not seem to be any growth opportunities, so they are just buying back stock to prop up the stock price, regardless of value. In my opinion, this is a horrible use of shareholder cash.
