-- Like Internet dating profiles ("Hot, wealthy Rhodes scholar seeks long-term relationship") and appliance-protection plans ("Honest, we'll replace your clock radio"), some things rarely live up to expectations.
The same is true when companies buy back shares of their own stock. Companies tend to announce buybacks with great fanfare. And though they don't say so, the implication is that the force of their buying will lift the stock. But corporate buybacks are often less than meets the eye. If you're really looking for smart buying, look instead to what the company's directors do.
Investors tend to sit up when they hear about buyback plans, and company analysts often coo excitedly when they hear that a company is buying back its own stock. The implication is that the company feels its stock is such a great buy that it's using its own money to buy some.
And at least in theory, a stock buyback should be a good thing. All other things being equal, if a company buys its own shares and thereby reduces the number of shares outstanding, then those that are left should be worth more.
In practice, though, buybacks rarely live up to their hype. Sometimes, companies announce a buyback but never get around to repurchasing the stock. In addition, many companies don't actually retire stock when they repurchase it. Instead, the stock sits in the company treasury, and the company uses it for other purposes. Companies may, for example, use it as stock awards for employees, or for matches in their 401(k) savings plan.
Now, it's better for the company to have the stock on hand when it wants to dole it out to employees, rather than having to buy it or issue more. Still, buybacks may not be the best use of a company's cash.
Let's say a company has $500 million that it can use for anything it wants. It can start a plant in Paducah or build a complex in Calgary. Instead, it uses that $500 million to buy its own stock — a move that indicates, at the least, a lack of imagination. Management should be able to think of things to do with a company's cash. That's its job.
Buybacks can also indicate timidity. A company with extra cash can pay it out to investors, in the form of dividends. But when a company pays a dividend, it's making an implied promise that it will do so indefinitely. Wall Street clobbers companies that cut or suspend their dividends. By choosing to repurchase stock rather than pay a dividend, the company may be indicating that it's not sure that its current prosperity will last.
Wouldn't the company know best when its stock is undervalued? Apparently not. A study by noted market sage Peter Bernstein showed that relatively few companies bought their stock in 2002, the bottom of the worst bear market since the Great Depression. Instead, he noted, companies waited until stock prices were much higher. Buybacks peaked in 2007, and the market's most recent top was in October 2007.
Standard & Poor's analysts Stewart Glickman and Todd Rosenbluth studied stock repurchases by companies in the S&P 500-stock index from Jan. 1, 2006, through June 2007. Their findings:
•A third of all companies took losses from their purchases. In other words, they bought too high.
•Three-quarters of the companies that bought back shares lagged behind the S&P 500 for the period.
•The most aggressive buyers of their own stock were some of the worst performers.
"The main takeaway is that investors have to be careful" when they hear about stock buybacks, Glickman says. They should see if the company has a good record of buying back stock when it's cheap. They should also check to see if insiders are selling stock when the company is buying.
In fact, purchases by company insiders are a better indicator of a company's future than buyback programs are. When an insider reaches into his own pocket and buys shares on the open market, you should pay attention.
Currently, insider buying is fairly low, says Ben Silverman, director of research for InsiderScore.com. Much of it is in small oil exploration and production companies.
You'll need to do more research — insiders can be wrong, too — but it's a good place to start.
John Waggoner is a personal finance columnist for USA TODAY and author of 'Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments,' available Monday from John Wiley & Sons publishers. His Investing column appears Fridays. Click here for an index of Investing columns. His e-mail is email@example.com.