The holidays are rapidly approaching. Unfortunately for us in the Upper Midwest, holidays often equal lutefisk. Lutefisk in our view has to be the worst holiday food tradition in the region, even worse than receiving a fruit cake. At least fruit cake can be re-gifted, often for years at a time—kind of like a culinary chain letter. When it comes to lutefisk, we would rather perform open heart surgery on ourselves than eat this alleged food. Some hearty souls claim to like lutefisk. In fact several years ago there were lutefisk microwave entrees. For most of us, the less lutefisk—the better.
On the opposite end of the scale, there are stock buybacks. The more we get, the happier most investors are. Usually for growth-oriented stocks we are not fans of stock buybacks. While we think it can be an effective way to return cash to shareholders in a tax-efficient manner, the timing and the amount of the buyback can dramatically impact the return on the company’s (and ultimately the shareholders’) investment. For instance, most share buybacks undertook during the 2006-8 timeframe likely did not deliver a good, if any, return for shareholders. Additionally, while a share buyback can grab headlines, oftentimes stock options and grants can dilute or even undermine the earnings per share impact of a buyback.
Furthermore, U.S. based companies usually use cash domiciled in the U.S. for a buyback—all from the same pile of cash used to pay dividends, U.S. based pensions, U.S. employee health care costs and many other expenses. This can leave far less cash for growth-oriented activities especially here in America. These activities can include additional property, plant and equipment that can lower costs in the long run or increase productivity and/or capacity, additional investments in research in development, U.S. based acquisitions, new marketing channel development and sales force enhancements. The expected return of the buyback has to outstrip all of those other potential uses for cash in our view to be worth the risk and potential long-term growth opportunity costs.
Having said that, there are times when buybacks are worthwhile and we need to incorporate the potential for them into our investment analysis. For instance, for companies with a cyclical bent, there may not be any worthwhile investments for the company’s cash other than purchasing their own stock at that point in the cycle. Additionally we also know that if the buyback is timed properly, it can enhance shareholder returns. It is also nice to have the company conceivably buying stock on pullbacks, potentially supporting the stock. Finally at the end of the day, an investor should be concerned with generating an abnormally good return over the investor’s investment horizon. Buybacks certainly play a role in that regard. Therefore, when there is a buyback announcement one may have a percentage of float number in mind that would make us take notice of it being material to the stock’s shorter-term potential investment attractiveness. Do you have such a number? What do you think?