Are Stock Buybacks a good sign

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Are Stock Buybacks a good sign

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Over the last few years, we’ve heard a lot about stock buybacks, and in fact, stock buybacks are at historically high levels. Many US companies, holding large amounts of cash are putting it to use by buying back their own stock. – PowerPoint PPT presentation

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Title: Are Stock Buybacks a good sign


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  • Are Stock Buybacks a good sign
  • Stock Buybacks Good or Bad
  • Author Hari Swaminathan

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About OptionTiger
  • Over the last few years, weve heard a lot about
    stock buybacks, and in fact, stock buybacks are
    at historically high levels. Many US companies,
    holding large amounts of cash are putting it to
    use by buying back their own stock. 
  • But what exactly does Stock buybacks tell us,
    and are they a good sign or bad ? There are
    several interpretations and it could mean one or
    more of the following

1) Generally, companies would (should) prefer to
deploy cash into additional revenue streams. This
could be opening new factories, new products,
invest in RD, or building new businesses. These
activities, over the long run, will produce a
higher return on capital than if the money was
just being held as cash. By using this cash
instead to buy back its own shares, perhaps is a
sign that these companies dont feel confident of
building additional revenue streams, at least in
the prevailing environment. 
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  • 2) Stock buybacks can also mean a company is
    having serious issues with growth, specifically,
    growing the bottomline. As we all know, companies
    are valued in the public markets based on several
    parameters, but the chief ones are earnings, and
    earnings growth. The exact metric is EPS
    (Earnings per share). If a company has an EPS of
    3/share, and the next year, they produce an EPS
    of 5/share, this is great. It shows that the
    company is growing nicely, right ? Well, this is
    the problem. Many companies use the
    stock buyback trick to mask poor earnings
    performance. When a company buys back stock from
    the market, there are fewer shares in
    circulation. As a simple example, if there were
    100 shares in the public float before a buyback,
    and a company buys back 25 shares, then there are
    only 75 shares in circulation. The EPS
    calculation now is much higher, and gives a false
    perception of growth or the health of the
    company. 
  • 3) Companies can be genuinely concerned about
    market conditions and/or their own stock price.
    If they feel their stock is undervalued, for
    whatever reason, it may be a good time to buy
    back some shares. And when the market eventually
    prices its shares according to what it deems to
    be a fair valuation, the company can make good
    profits by selling it back at that time. There is
    nothing wrong with this move. Its just taking
    advantage of temporary situations in the markets.
    The key indicator is to see how much was the
    buyback relative to their other normal business
    investments for the year.

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  • - How does the amount of stock buybacks compare
    to say, their usual investments into new products
    or RD. If a company normally (average last few
    years) invests 100M into RD, and this year they
    invested only 20M but were involved in a large
    stock buyback, that does not sound good. 
  •  
  • Whatever the reasons are, retail investors
    should make sure it passes the smell test. A
    quick review of the financial statement should
    clearly reveal the nature and amount of buybacks,
    the reasons the company gives for these buybacks,
    and your own investigation into the numbers
    should reveal the true picture. If it smells
    fishy, then it probably isNot every
    Stock buyback is to be interpreted as negative,
    although a majority are in some respect or the
    other. 

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  • As we can see, there are some good reasons to
    buy back your own Stock, and there are some
    reasons that are not. So how can a retail
    investor figure out which one is it ? Well, if
    youre a fundamental investor, you must be
    familiar with poring through financial
    statements. This is the basis of your investment
    philosophy. There is plenty of information you
    can glean from financial statements. For
    example, 
  •  
  • - How was revenue growth and compare that to EPS
    growth ? If you see strange numbers like revenue
    increased by 5 but earnings increased by 20,
    that does not sound right. Youll need to look
    for reasons why this happened. There may be a
    genuine reason like a major cost cutting
    initiative that panned out very well. But
    whatever the reasons are, its important to
    understand them.

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