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Buybacks take a beating

The stock-pumping tactic may have lost its mojo.

Last Updated: October 17, 2008: 8:37 AM ET

Market mover or misstep? Microsoft recently tried to send Wall Street a message.
Buybacks lose their luster Buybacks lose their luster Buybacks lose their luster
Stock buybacks used to guarantee an instant stock boost. Not anymore.

(Fortune Magazine) -- Last month, Microsoft announced it was going to spend $40 billion buying back its own stock. Traditionally, that would have meant a payday for its investors. With Microsoft using its own spare cash to reduce the number of outstanding shares, earnings per share should have improved, and the stock price should have ticked upwards.

But a funny thing has happened since the announcement: Microsoft's stock got a slight bump, then quickly tumbled.

Microsoft (MSFT, Fortune 500) is not alone. Nike (NKE, Fortune 500) and Hewlett-Packard (HPQ, Fortune 500) have also recently announced buybacks that fizzled (but what hasn't in this market?). This has prompted shareholders and CFOs to wonder whether buybacks are another false god of the bull market or merely collateral damage of the credit crisis.

"Buybacks were almost as good as firing 1,000 people," says Howard Silverblatt, senior index analyst at Standard & Poor's.

Between 2003 and 2007, the amount of cash S&P 500 companies spent on buybacks nearly quadrupled, from $135 billion to $590 billion. The higher the market rose, the more shares companies bought. The peak of this "buyback bubble" occurred in the third quarter of 2007, when the Dow was at 14,000.

During that time financial services companies including Bear Stearns, Lehman Brothers, and Freddie Mac (FRE, Fortune 500) were buying up their own stock like crazy when their spare cash might have been better spent deleveraging their balance sheets. "It was bizarre how companies were repurchasing at such high levels," observes John Graham, a finance professor at Duke University who surveys CFOs on their repurchasing plans.

Take the case of Merrill Lynch (MER, Fortune 500). In February 2006, Mother Merrill, flush with cash, announced plans to buy back $6 billion in stock, more than doubling its previously announced repurchase plan.

At the time, Merrill's stock price got a nice boost, rising almost 2% that day - and more than 20% for the rest of the year, to $89. If you sold then, the buyback treated you right. But any long-term shareholder got trounced: Since then, Merrill has lost 80% of its value and agreed to be taken over by Bank of America (BAC, Fortune 500).

So how should investors view buybacks in today's tempestuous market? The irony is that this might be the time to have any real faith in them. Right now only companies in decent shape - generating real, secure cash flow and not dependent on the debt or capital markets - can afford to buy back stock, and this is a chance to get the stock cheap.

"Look at Microsoft. The Yahoo deal didn't work out. Now it's got all this cash, and it's looking for a place to put it. So this is like Microsoft saying it thinks that it is the best investment out there," says Art Hogan, chief market analyst with Jefferies & Co. "The message you are sending out is you think your stock is a bargain."  To top of page

Company Price Change % Change
Bank of America Corp... 16.15 0.00 0.00%
Facebook Inc 58.94 0.00 0.00%
General Electric Co 26.56 0.00 0.00%
Cisco Systems Inc 23.21 0.00 0.00%
Micron Technology In... 23.91 0.00 0.00%
Data as of Apr 17
Index Last Change % Change
Dow 16,408.54 -16.31 -0.10%
Nasdaq 4,095.52 9.29 0.23%
S&P 500 1,864.85 2.54 0.14%
Treasuries 2.72 0.08 3.19%
Data as of 11:20pm ET
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