Share Repurchases: Investment Killers

By Daniel Miller - October 17, 2012 | Tickers: HPQ, NFLX, PFE, TWX | 0 Comments

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Am I the only person that thinks share repurchases seem really, cocky? It’s like saying the best possible place in the universe for cash is my own stock. Um, I'll take that bet, Vegas has odds slightly in the universe’s favor.

Or maybe it’s the CEO saying I’m too lazy or overwhelmed to find better ways to use the cash. It’s my personal opinion as a shareholder, that I’d rather have that extra cash used in a dividend or to assist growth.

It’s easy for me to sit here and look for examples in the past and say they were terrible moves. The real question is what it means for those companies and shareholders moving forward. Let’s look at some red flags that signal for further research. Then I’ll display some company buybacks that could be hurting investors.

Red Flags

There’s a lot of angles to look at when considering all aspects of a share repurchase. In this article I’m going to cover some of the risks and things to investigate further. One red flag and shady move that I look for is a stock repurchase timed before earnings announcements; especially if the company’s CEO compensation is based partially on EPS. Stock repurchases can give a quick boost to EPS with no increases in net income because it reduces shares outstanding.

Hewlett-Packard

In 2009, Hewlett-Packard (NYSE: HPQ) CEO (at the time), Mark Hurd, received his $30 Million bonus compensation, which was based off three factors. Can you guess what one factor was? Yep, Earnings Per Share. The $10 Billion repurchase of shares beforehand may have aided in the increase in EPS for his compensation. Let’s make one thing clear. Management can’t play games like that for long, Wall Street and/or the board will figure it out. From that point going forward, Mark resigned the CEO position following an investigation that found violations of business conduct. The CEO position went into a volatile period finally ending with Meg Whitman, who’s trying to turn the ship around. Going forward I think HP is in a much better position with better management. This year has been a rough ride for HP stock price, but I have no doubt better decisions on spending cash for growth are being made.

Flyin’ High

A second red flag I look for is when companies repurchase shares while the company is near a 52 week high. There’s really limited reasoning behind this. Either one, the company has something in the works they know will boost the stock’s value. Or two, EPS manipulation I mentioned above. One way to look a little deeper is to check out the companies Price to Earnings ratio compared to the industry. If it’s substantially higher, that means the company is paying a premium for its own stock, which doesn’t make much sense.

The Netflix Crash

Netflix (NASDAQ: NFLX) buyback problems are old news, but it serves a good example of the red flag mentioned above. Throughout 2011 Netflix spent $199 Million on share buybacks at an average price of $221 per share. I’m not even going to show you a graph because if you’re reading this you know Netflix has crashed to the ground. This is why I hesitate to invest in companies repurchasing shares near a 52 week high. Netflix was on my watch list and I remember thinking they should be using that extra cash for better or more content for streaming purposes.

Pfizer and Time Warner. Ouch.

Here are a couple long term examples.

I’m merely going to scratch the surface here for a top level conclusion. Since 2004 Pfizer has spent 32.4 Billion and Time Warner has spent 30.3 Billion on buy backs, most of which have lost value except for recent purchases in 2011 and 2012. Even with the loss in share price, investors might be alright with the share repurchases if there is a steady increase in EPS. Here’s a table showing the EPS since 2004.

Going forward with Pfizer

For Pfizer (NYSE: PFE) that’s not what I want to see as an investor after 32.4 Billion in share repurchases. Clearly that 32.4 Billion could have been spent in better ways. Pfizer’s repurchase program has hurt them overall. Pfizer plans on offering 20% of its Zoetis (animal health business) in an IPO. It’s also selling its nutrition business to Nestle for $11.8 billion. What’s Pfizer going to do with this cash? It’s going to share repurchases and business development. Pfizer has 3 major drugs in the R&D cage waiting to be released. I’d prefer more of that cash going into R&D, especially in the pharmaceuticals industry.

Going forward with Time Warner

Time Warner (NYSE: TWX) Of these examples, I’m satisfied with their repurchase program the most. Along with announcing a new $4 billion repurchase program in February, they also raised the dividend by 11%. That’s enough to keep me from complaining too much. Time Warner has seen a jump in EPS, I just don’t think it can be contributed much to the 30.3 Billion spent in share repurchasing. Time Warner is having a lot of success presently, with syndicated television shows Two Broke Girls, Mike & Molly, and Person of Interest. Time Warner also boasts successful movies and highly anticipated flicks. Including Dark Knight 2, The Hobbit 1 and 2; The Hangover 3; Superman. Keep pumping cash into those ventures Time Warner, Please!

Bottom Line
Steve jobs said “Innovation distinguishes between a leader and a follower.”When I invest in companies, I want to see cash going into R&D and growth initiatives, not share repurchases. I strongly feel that companies could put cash to better use. I would choose a dividend over a repurchase program. I also feel like when EPS is a factor of CEO compensation and we see share repurchases, further research should be done before an investment is made. Netflix, Pfizer and Time Warner were hurt by their repurchasing programs and going forward should reconsider how they spend their excess cash.

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