Few people can resist a bargain. And when the chairman of the XYZ Corp. picks up his newspaper and sees that his company's stock, which is worth $4 a share, is trading for only $3, the chairman is very likely to call the XYZ directors and tell them, "Let's buy back some of our stock."
Stock buybacks are a common event these days. And when stocks fall sharply, as they did in August, the number of buybacks rises sharply. A long list of companies in the Baltimore-Washington-Richmond region announced buybacks in recent months. But the pace quickened last week.
McCormick & Co., the spice company located in Hunt Valley, Md., said it would buy up to 2 million shares in the open market. McCormick, which has 40.6 million shares in the hands of investors, recently completed a 2.1 million-share buyback.
McCormick is typical of the type of mature industrial company that most often does stock buybacks with its excess cash.
Then, there was Danaher Corp. of Washington, the industrial company run by the Rales brothers. Danaher said it would buy another 1.5 million shares. It recently acquired 1.6 million shares, including about 119,000 shares that were bought last week. Danaher has about 23.3 million shares outstanding.
One result of the buybacks will be that the percentage of total stock owned by the Rales will to continue to increase. They already own about 44 percent of Danaher.
Many of the area's biggest companies have bought back their own shares at various times. They include the Marriott Corp. and The Washington Post Co. And Geico Corp. has been buying stock for many years.
Not all buybacks actually take place as contemplated. In November 1987, shortly after the October market crash, T. Rowe Price Associates Inc., the Baltimore mutual fund company, was looking at a $10 share price, adjusted for a 2-for-1 split. The board decided the price was low enough to buy 700,000 shares, about 5 percent of its stock.
But T. Rowe Price's business picked up and its stock kept rising, getting as high as $31 earlier this year. As a result, the company has bought only about 155,000 shares, or about 1 percent of its stock.
With the slide in bank and thrift stocks during the past year, many financial institutions also have announced buybacks. But the demands of federal regulators for bigger safety cushions at banks and thrifts are likely to derail such buybacks in the future.
Signet Bank, for instance, did a 500,000-share buyback earlier this year at an average cost of about $26.43 a share. Today, Signet stock is at $15.25 and the bank could buy stock even more cheaply. But the bank isn't likely to do so, officials said, because in the present banking climate, it is simply more prudent to hang onto one's capital.
Similarly, Dominion Bankshares Corp. bought back 1.2 million shares of stock during 1989, when the stock sold between $16.25 and $26.12. This year, the bank authorized a buyback of 1.5 million shares. But even though the stock is now at $11.50, Dominion will not buy any more. The bank wants to keep its capital intact, said spokeswoman Brenda L. McDaniel.
One of the perplexing questions in the world of finance is whether stock buybacks are good or bad for stockholders. Most analysts and market observers tend to think that, on balance, stockholders profit when companies buy back their own shares. But they acknowledge that buybacks may have a negative side, as well.
Blanket conclusions about buybacks are difficult because the alternatives may not always be clear.
A corporate executive with $10 million to spend, for instance, can tell quite easily what will happen to the company's financial picture if the money is used to buy stock. But it is much trickier to estimate what kind of return the company will get if it invests the $10 million in research and development or uses the money for an acquisition.
Diversification often becomes what mutual fund investor Peter Lynch once called "de-worse-ification."
The pros and cons of stock buybacks go something like this:
When a company says that it is going to buy back shares, it is saying to the Wall Street community, "We believe that our stock is a good buy at this price, and we think this is the best investment we can make with our money." This has public relations value because it shows the executives have faith in their own firm.
Of equal importance, of course, is that the buyback will reduce the number of shares the company has out in the market. Thus, when profits are calculated, fewer shares will mean that the earnings per share will go up. Because stock prices are tied to company profits, a rise in profits per share normally will boost the stock price.
One other consideration is that for a company that pays dividends, each share retired will be one less share on which the business will have to pay dividends. And that could produce considerable savings.
On the negative side, a company that buys back too much stock can reduce the amount available for trading -- making the shares less attractive to major investors.
In small companies, buybacks also can be used by company officials to increase their own percentage of control.
It is sometimes argued that a company should use its extra cash to pay a special dividend. But stockholders would then have to pay taxes on that dividend and many stockholders would rather see the price of their shares rise than face added taxes.
Many companies also prefer to maintain a steady pattern of dividends. A one-time special dividend would mean that the next dividend payment would be lower than before, an event that could be misinterpreted.
Yet, many observers continue to be puzzled by some aspects of buybacks.
John Markese, director of research at the American Association of Individual Investors, says that despite the advantages to companies, investors are tempted to ask, "Why don't they go out and invest in new products and business opportunities?"
In some cases, Markese notes, companies say they can't find good opportunities and in other cases, the risks may seem too high.
One major effect of a buyback on a company's bookkeeping is to increase or decrease its basic value, or book value per share. Book value is arrived at by deducting liabilities from assets and dividing by the number of shares.
Book value per share is an important number for company officials to consider when deciding whether to buy back their stock.
Using the XYZ Corp., let's look at an example kindly provided by William T. Russell, chief financial officer of Second National Federal Savings Bank.
The XYZ Corp. has 500,000 shares outstanding. It has a $4 per share book value. It earned $200,000, or 40 cents a share, last year and will earn the same this year.
This is what happens to the earnings per share and the book value per share when the XYZ Corp. decides to use $500,000 of its excess cash to buy back stock:
If the stock is selling at $4 a share, equal to the $4 book value, XYZ will be able to buy 125,000 shares, leaving 375,000 shares in the market. The book value will remain at $4 and the $200,000 in earnings will produce a profit of 53 cents a share instead of 40 cents.
If, however, XYZ Corp. can buy back its stock at $3 a share -- well below book value -- the company will be able to purchase 167,000 shares, leaving 333,000 shares. The book value will go up to $4.50 a share and the earnings on the $200,000 will rise to 60 cents a share.
On the other hand, if the XYZ Corp. were to buy back stock at $5 a share -- well above book value -- it would be able to buy only 100,000 shares, leaving 400,000 shares. The book value would then fall to $3.75 a share, and the earnings would go up to only 50 cents a share.
Thus, if the chairman of XYZ Corp. is going to buy back shares, the best time to do it will be when the stock is trading at or below the $4 book value price.
The cheaper the price of the stock, the more shares the company can buy, the fewer shares will be left in the market, the higher the earnings per share will go, the greater the increase in the book value per share and the higher the stock price will rise.
And that, in short, is why companies love to buy back their shares -- especially when the price is right.endquad