Richard Karpel, here is what Josh Carlson (Morningstar) wrote about buybacks. I was commenting about the very last sentence.
The Basics
Stock buybacks, also known as stock repurchases, are simply one way for a company to make use of excess cash. Excess cash can typically be deployed in one of three ways: buying new companies, reinvesting in the existing business (such as R&D or capital expenditures, or to pay back debt), or distributing money to stockholders in the form of a dividend or a stock buyback. In making the decision to repurchase shares, therefore, company management is implicitly making the claim that this is the best use of resources, though that may not always actually be the case.
The Whys and Wherefores
Corporations may choose to engage in share buybacks for several reasons. As mentioned above, the most straightforward reason may simply be that the stock represents a good value. Company managers are naturally sensitive to the price of their stock, and if the price is stagnant or depressed and they believe business is better than the price reflects, a buyback may well be an efficient use of resources. The spate of recent buyback announcements indicates that these companies think the market is overreacting and creating short-term opportunities. Under normal circumstances, an investor might prefer a company to invest in the business, but if the only alternatives are an underperforming business unit or an uncertain new venture, then a stock buyback may well be in order.
A more pragmatic reason for stock buybacks is to reduce the dilution caused by company stock-option plans. Such plans have become an increasingly larger part of company compensation plans, and the bull market of the 1990s has expanded the value of existing options, in some cases hugely. Thus, from time to time some companies will repurchase shares to avoid the excessive dilution that may occur as more and more options are granted and later exercised.
A final, and more questionable, motivation for a company to buy back shares is to prop up a lagging stock price. A stock price may get a boost from the temporarily higher trading range (as in the case of PP&L) as well as from the show of support demonstrated by the company. Moreover, the reduction of shares has an accounting effect on earnings per share, price/earnings ratios, and ROE, which makes the numbers look better even though performance is the same. There's nothing wrong with a company's wanting to support its stock price from the perspective of a shareholder, of course, but only if purchasing stock is really the best long-term allocation of capital. |
