A Modest Year
Record Buybacks in 2005 Failed to Spark Big Rally

By Ben White
Washington Post Staff Writer
Friday, December 30, 2005

NEW YORK, Dec. 29

Absent an unlikely major rally, Wall Street will close out the trading year on Friday with modest gains, well short of what many strategists predicted when 2005 began.

The tepid returns come despite the emergence of a powerful group of stock buyers this year: companies themselves.

According to preliminary estimates, public companies bought back about $400 billion worth of their shares in 2005, shattering the previous record of $257 billion set last year.

Typically, such buying tends to lift individual stocks and the market as a whole. But that didn't happen this year. Analysts said that is because investors did not fully embrace stock buybacks as a positive signal about the strength of domestic companies. Many continued to ignore U.S. firms and instead put extra cash into international markets, real estate and government bonds.

"Historically, every year that companies were net buyers of shares, as far back as we have data, the market has gone up," said Charles Biderman, chief executive of TrimTabs Investment Research, which monitors buybacks and mutual fund flows. "This year the market has gone up much less than it should have." The main reason, he said, is that individual investors put much more money into global equity funds than into U.S. funds. "As a result, global markets have outperformed."

The Dow Jones industrial average is essentially unchanged this year. It closed at 10,784.82 on Thursday, down 11.44 points, or 0.1 percent, from Wednesday. The Dow is now a mere 1.81 points higher than it was on Dec. 31, 2004.

In contrast, the Dow Jones Stoxx 50 index of European shares is up more than 20 percent this year, and the Dow Jones Asian Titans 50 index of top Asian companies is up 19 percent. Large amounts of capital, much of it from abroad, also poured into Treasury bonds this year, helping keep long term rates low even as the Federal Reserve pushed up short-term rates.

The broader U.S. stock market fared somewhat better this year than the industrials, which were dragged down by faltering giants such as General Motors Corp., down 52 percent for the year. The Standard & Poor's 500-stock index on Thursday closed at 1254.42, down 3.75 points, or 0.3 percent, for the day but up 3.5 percent for the year. That is much less than many expected, especially considering the amount of corporate stock-buying.

The technology-heavy Nasdaq composite index closed at 2218.16 on Thursday, down 10.78 points, or 0.5 percent, and up only 2 percent for the year.

The buybacks came from every sector of the market, led by giant companies such as Exxon Mobil Corp., which used cash generated by record high oil prices to buy back nearly $13 billion worth of its shares, according to TrimTabs. Exxon Mobil's stock is up about 10 percent this year.

In the Washington area, software firm MicroStrategy Inc. said in June that it would buy back up to $300 million worth of its stock. The company bought back 2.5 million shares in the first half of the year. MicroStrategy's share price is up around 40 percent this year.

But many stocks have not gained much after buyback announcements. For example, Reston-based home builder NVR Inc. said in November that its board had authorized a $300 million share repurchase. NVR's share price is up about 2 percent since the announcement. Microsoft Corp. bought back about $9 billion in stock in 2005, according to TrimTabs. But Microsoft's share price is nearly unchanged for the year.

Experts said the modest returns indicate that investors did not embrace buybacks as much this year as they have in the past. Investors typically view buybacks as an indication that corporate executives are enthusiastic about the future and believe shares in their firms are undervalued. This year, however, investors seemed to worry that buybacks might indicate that executives could not find more profitable ways to deploy cash, such as building new plants. "The most direct inference that can be drawn is that companies are still somewhat cautious about how to redeploy their capital," said Steven P. Clark, a finance professor at the University of North Carolina at Charlotte.

Analysts said foreign-profit repatriation could be another factor driving buybacks. Under a one-year tax holiday, companies brought home $200 billion or more in foreign profit in 2005. The tax break forbids companies from using the money to buy back stock. But because they did not have to specify what they used the money for, analysts suggested that some of the repatriated profit went to buybacks.

Pressure from activist investors to return money to shareholders also has driven buybacks. Time Warner Inc. announced last month that it would more than double its buyback program, to $12.5 billion from $5 billion, under pressure from corporate financier Carl C. Icahn.

Biderman, of the TrimTabs research firm, said the market impact of recent buybacks, coupled with increased dividends paid by cash-rich companies, will be felt next year as investors grow more confident about the economy and the ability of corporations to keep increasing profits. "Absent some kind of shock to the system, the market should soar next year," Biderman said. "There is just a ton of cash out there." Other experts said a continued slowdown in returns from real estate investments also could send more money into the equity market, as could a halt to the Federal Reserve's campaign of raising interest rates.

If such a market boom does arrive in 2006, which stocks would benefit?

In 2005, the energy sector once again dominated, driven by soaring oil and gas prices. Health care, biotechnology, utilities, financial stocks and basic materials also fared well. Shares of smaller companies, which raced ahead in the beginning of the current economic cycle, finally slowed in 2005 and mid-size firms thrived. Analysts expect that trend to continue in 2006 as economic growth slows. Some also expect big companies, such as those in the S&P 500, to do well because their shares now trade at modest valuations.

Potential pitfalls in 2006 would include a collapse of the housing market, a major terrorist attack or more devastating hurricanes. In addition, 2006 is a congressional election year, which could bring political upheaval to Washington.

Typically, when an incumbent president is in his second term, as President Bush is now, the opposition party picks up seats in Congress. In 1986, for example, Democrats regained control of the Senate in the middle of Ronald Reagan's second presidential term. Despite the turmoil, stocks posted double-digit gains. Experts said the market could be choppy heading in to the 2006 elections but might once again emerge with strong gains after the uncertainty is resolved, regardless of the outcome.

Movers

Hilton Hotels rose $1.70, to $24. The company said it would acquire the British Hilton Group for $5.6 billion to create the world's largest hotel company.

Wal-Mart Stores fell 36 cents, to $47.48. It said sales of gift cards were better than expected during the holidays but did not provide figures.

General Motors rose 40 cents, to $19.01, even though Credit Suisse First Boston predicted double-digit sales declines.

Ford Motor fell 3 cents, to $7.81.

DaimlerChrysler rose 21 cents, to $51.58.

Indexes

New York Stock Exchange composite index fell 7.62, to 7788.14.

American Stock Exchange index fell 1.39, to 1757.54.

Russell 2000 index of smaller-company stocks fell 2.12, to 677.96.

Volume

NYSE: 1.44 billion shares, down from 1.47 billion on Wednesday. Decliners narrowly outnumbered advancers.

Nasdaq : 1.21 billion shares, down slightly from Wednesday. Decliners outnumbered advancers 5 to 4.

Commodities

Crude oil for February delivery: $60.32, up 50 cents.

Gold for current delivery: $515.70 a troy ounce, up from $514.20 on Wednesday.

Associated Press contributed to this report.