Using buybacks to help pick stocks
Here are three firms that wisely repurchased their shares at recent lows -- not peak prices.
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| Pat Dorsey is the director of equity research for Morningstar. |
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(Money Magazine) -- The top job of managers at every company is the same: allocating capital. Should money be spent on internal growth or acquisitions? Should capital be returned to shareholders via dividends or share repurchases?
In general, American corporations make pretty good decisions, posting some of the highest returns on capital in the world. Given that, you might assume managers who spent almost $600 billion on share repurchases in 2007 would have been snapping up their own stock even more aggressively in late 2008 and early 2009, when prices cratered.
Alas, you'd be wrong, as buybacks plunged to $31 billion in the first quarter, as firms hoarded cash in the credit crunch. The halt in buyback activity can be viewed as a sign of financial worry. But you can also look at the timing of buybacks to help you gauge whether firms make sound decisions with money.
Disney (DIS, Fortune 500), for instance, spent nearly $4.5 billion on repurchases in its fiscal year 2008, when its shares hovered in the high-$20 to mid-$30 range. Yet buybacks in the Magic Kingdom nearly dried up this fiscal year when the stock was much cheaper.
What's more, Disney said it will issue almost 60 million shares to complete its purchase of Marvel, and it has committed to buying back those shares in the 12 months after the deal closes -- most likely at higher prices than earlier this year.
This kind of behavior drives me nuts. So like Diogenes searching for an honest man, I went looking for those few firms smart enough to recognize that their shares were cheaper in early 2009 than before the bear. Here are a few favorites.
ExxonMobil (XOM, Fortune 500). The oil giant repurchased $13.1 billion of its shares in the first half of 2009. While that was less than the $18.2 billion it spent in the first half of 2008, Exxon deserves credit for continuing its program in a depressed market. At Morningstar, we think these shares are about 20% undervalued, so this is likely to be money well spent.
Apollo Group (APOL). This for-profit educator -- which runs the University of Phoenix -- was smart enough to buy back more than 4.5% of its stock in early 2009, when its price/earnings ratio was 18% lower than in the prior two years.
Thermo Fisher Scientific (TMO, Fortune 500). In the first half of '09, the lab-equipment maker spent $415 million on buybacks, more than twice what it spent in '08, when its P/E was 56% higher.
Buying more when prices are down -- it's not just a novel concept. It's a sign of smart management.
Pat Dorsey is the director of equity research for Morningstar. 
