4 Companies Investing in Themselves
By: Todd Bunton
January 06, 2011
While consumers may be struggling to keep cash in the bank, companies are flush with it these days. In fact, non-financial companies in the United States have nearly $2 trillion sitting in cash.
That’s a serious amount of dough.
Time to Put that Money to Work
During the financial panic, it made sense for companies to stash cash as a defensive position. As the economy continues to improve, however, the question now becomes - what will these companies do with all that cash? With money market funds and Treasury bills paying paltry returns for the foreseeable future, businesses need to find other places to put their money to work.
There are plenty of choices. Companies could spend that cash reinvesting in current operations, acquiring other firms, or through capital spending - investing in projects in hopes of earning high rates of return. Another option would be to distribute excess cash to shareholders through higher dividend payments. Or, the company could invest in itself; that is, buy back shares.
Investing in Themselves
When a company announces a stock buyback, it’s a powerful signal to investors that management is confident in the long-term outlook of the company and that the share price is fundamentally undervalued. A common theme throughout most share repurchase announcements reads something like:
"We feel the best use of our cash was to invest in ourselves."
Or,
"We believe the market has significantly undervalued our stock."
While this may be the case, corporate executives usually aren't ones lacking in confidence, and most will tell you that their company’s stock is undervalued.
More than Fluff
When the company actually buys back its shares though, it has a direct benefit in that it reduces the number of shares outstanding. This means that earnings are divided among fewer shares. In other words, your piece of the pie just got bigger.
Consider an example. ABC Corp decides to buy back a big chunk of its shares outstanding. It has $100 million sitting in cash and would like to allocate $60 million towards share repurchases. The current stock price is $15, so 4 million shares are bought back.
After the buyback, each share just became much more valuable. Assuming the prospects of the company don't change and investors are still willing to pay 15 times EPS like they did before ($15 share price ÷ $1.00 EPS), your shares are now worth $25 (15x $1.67 EPS). That’s a 67% return without earnings actually growing.
Use Caution
Stock buybacks don't always add value, however. If a company commences a share repurchase in a stock that is overvalued, obviously it’s not a good investment. The money would have been better spent paying a dividend or investing in a value-added project, or even just sitting in the bank. Make sure you look at the underlying business before investing in a company, because all the buybacks in the world won't save a company headed off a cliff.
Yet for companies with rising earnings, reasonable valuations and some excess cash, a stock buy back can be a great way to return value to shareholders.
Here are 4 companies doing just that:
Herbalife (HLF - Snapshot Report) announced on May 3, 2010 that it was authorized to spend up to $700 million buying back shares through the end of 2014. This represents a whopping 23.8% of total shares outstanding. The company has spent $106 million in the first nine months of 2010 repurchasing shares.
That's one way to grow EPS.
The other way is to grow earnings, which it has been doing quite well lately. In the third quarter of 2010, Herbalife reported a 31% increase in net income year-over-year on 15% sales growth. Management also raised its guidance for the remainder of 2010 following the strong quarter. Analysts expect the company to grow EPS 40% in 2010 and 15% in 2011. It is a Zacks #2 Rank (Buy).
The valuation picture looks attractive too. Shares trade at 13.0x forward earnings, a discount to the industry average of 17.4x. Its PEG ratio is 1.0.
Herbalife is a global network marketing company offering a range of science-based weight management products, nutritional supplements and personal care products intended to support weight loss and a healthy lifestyle.
Medco Health Solutions, Inc. (MHS - Analyst Report) is the largest pharmacy benefit manager in the United States. Its programs and services help clients enhance the quality and control the cost of the prescription drug benefits it offers to members.
The company has bought back approximately 10% of its shares outstanding in the last 12 months while growing net income 11% over the same period. Since 2005, Medco has spent over $10 billion buying back 240.4 million shares. In May 2010, the Board of Directors approved a new $3 billion share repurchase program through May 2012.
The buyback looks like a good investment with shares trading at 15.0x forward earnings and a PEG ratio of only 1.0. Business is looking good too, with earnings per share expected to grow 20% in both 2010 and 2011. It is a Zacks #2 Rank (Buy) stock.
Fossil (FOSL - Analyst Report) is another strong company that has chosen to invest in itself. Both the share price and earnings estimates have been soaring for the watch and accessory maker as it has delivered 7 consecutive positive earnings surprises. Earnings per share are expected to grow 76% in 2010 and 16% in 2011. It is a Zacks #1 Rank (Strong Buy) stock.
During the third quarter, Fossil's board authorized the repurchase of $750 million in common shares through December 2013. The company already spent $57.1 million of that buying back 1.1 million shares in the quarter.
Although the stock has nearly doubled since early July, shares still appear to be reasonably priced. FOSL trades at 17.1x forward estimates, in-line with its peers, and sports a PEG ratio of just 1.1.
International Business Machines (IBM - Analyst Report) has over $11 billion in cash and short-term investments on the books despite spending nearly $12 billion in the first nine months of 2010 buying back its stock. The company has been aggressive in reducing its share count for quite some time now. Since 2005, for instance, IBM has repurchased over 20% of its common shares outstanding.
It looks like this trend will continue. On October 26, 2010, the company announced its board of directors had authorized an additional $10 billion for use in its common stock repurchase program.
That seems like a good use of cash at these levels. Shares trade at just 11.7x forward earnings, a significant discount to the industry average of 23.4x. Its PEG ratio is a reasonable 1.3.
Business is looking good too for the tech giant. Earnings estimates have been trending higher, and analysts expect EPS to grow 14% in 2010 and 10% in 2011. It is a Zacks #2 Rank (Buy) stock.
Conclusion
With the economy improving and cash representing the highest percentage of total assets since 1959, it's time companies start putting that money to good use. One way is to invest in itself and buy back some shares.
That is, of course, if the company is worth investing in.
Todd Bunton is the Growth & Income Stock Strategist for Zacks.com.
