When industry veterans are asked to join a company's board of directors, they are expected to stick around for many years. That gives them the accumulated knowledge of a company's operations, industry positioning and economic sensitivity to help guide forward-looking investment planning decisions. And right now, many of these directors are advising company management to direct funds into one key area: stock buybacks.
These directors know that their companies are weathering the current tough economy in decent -- if not robust -- shape, and they know that even better days lie ahead as the economy improves.
So as these companies keep piling up cash quarter after quarter, their own stock is turning out to be a solid investment. In recent quarters, I've noticed an explosion in stock buyback activity, and the current quarter is no exception.
Here's a look at all of the companies that have announced new (or extended existing) buyback plans of at least $500 million thus far in the second quarter.
When it comes to judging buyback stocks, there are two things to keep in mind. First, the buyback should equate to a hefty portion of the existing share count in order to meaningfully shrink the denominator part of the EPS equation. Visa's (NYSE: V) $1 billion buyback may seem impressive, but it represents just 1% of company stock.
Second, buybacks should be the response to low valuations and not simply because cash is lying around. The S&P 500 currently trades for around 12 times projected 2013 profits, and you want to focus on stocks that have a lower multiple than the broader market. With those factors in place, the list of buyback candidates for further research can be narrowed down to these six companies.
These stocks all sport low multiples because they are either in an operational slump at the moment, or they operate in a sector that is cyclically out of favor. For example, insurance firm Unum (NYSE: UNM) may appear to have a very low multiple, but so do other insurers such as Prudential Financial (NYSE: PRU), Met Life (NYSE: MET) and Hartford Financial (NYSE: HIG). So shares are unlikely to rally until the whole sector does. At least Unum is wise enough to buy back shares while the company's stock is valued at roughly two-thirds of book value. Any buybacks done at "below book" prices are simply a no-brainer.
Ideally, you want to see buybacks done at multi-year lows. So the fact that shares of railroad freight transporter Norfolk Southern (NYSE: NSC) is buying back stock while it's near a five-year high can be a bit off-putting. Instead, if you're looking for a better investment in this sector, my colleague Mike Vodicka recommended an intriguing stock in this article.
Thank you Mr. Einhorn
By a perverse logic, noted Wall Street short-seller David Einhorn has done nutritional supplement firm Herbalife (NYSE: HLF) a big favor. Einhorn gently suggested in late April that the company was boosting sales by counting revenue when its network of third-party re-sellers were ordering from the company -- and not end-users. He asked pointed questions on the first quarter conference call that greatly spooked investors.
It's too soon to know if his concerns are off the mark, but recently-released second-quarter results didn't show any signs of distress. In fact, Herbalife delivered earnings of $1.10 per share that were roughly 10% ahead of consensus forecasts and roughly 25% higher than a year ago. And Einhorn was noticeably absent from the recent conference call. Still, the damage has been done, and shares remain well below levels seen in the early spring.
The resulting selloff will enable Herbalife to get even more bang for its buck with a just-announced $1 billion buyback plan that could shrink the share count by one-sixth. Presumably, management wouldn't be foolish enough to commit such a large sum of money if end-user sales were indeed as weak as Einhorn was suggesting.
Risks to Consider: Buybacks can turn out to be a big mistake if the economy slumps badly and the companies later realize that it would have been nice to have that cash lying around for other purposes.
Action to Take --> One of the biggest reasons to buy stocks of companies that are engaged in buybacks is the defensive nature of the strategy. Companies that are buying back stock can step in and provide share price support when most other stocks are only seeing selling pressure. If you can find stock buybacks being done at below-market multiples and they are consuming a large portion of the share count, then you may have just found your next investment.