Tuesday, October 27, 2009

IBM to increase share buyback. Is that good? (IBM)

I've written previously about stock buybacks, and whether they're in the best interest of shareholders. Today IBM's board has decided to increase their current stock-buyback program by an additional $5billion.

Buybacks, in my opinion, do little if anything for shareholders. IBM management is not in the business of stockpicking, yet here they are using excess cash to buy shares just below 52-week highs. I'm by no means trashing the company -->> IBM's low PE and 10%ish Free Cash Flow Yield are why I don't see the major downside for the Dow30 that others do.

That said, management should really only be in the "capital allocation" business at it applies to running the company -->> investing in high ROI projects internally, or buying undervalued assets externally. The number one way they'll boost the value of the company is by increasing earnings and cash flow. The point is, leave the stockpicking to investors. The way to do that is through one time dividends as a way to return cash to owners of the stock.

In an excel snapshot below, you can see what changes in a stock buyback. Net income stays the same(except for slightly less interest income on the cash), but earnings per share goes up due to less shares outstanding. So the Price-to-Earnings goes down, making the stock more attractive, right? No not really, as you should have previously "netted out" the company's cash from the stock price. After adjusting for higher EPS and lower cash per share after the buyback, the valuation has not changed.

What we're left with to decided is whether management is making a good stock pick. In IBM's case I think the stock is undervalued. But I still would rather they dividend the money back to shareholders, or invest in valuable projects that will increase future earnings and cash flow.

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