WSJ's Arends: Troves and Tripwires of Stock Buybacks

Sunday, 23 Dec 2012 10:52 PM

By Dan Weil

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Corporate stock buybacks have embarked on a major ascent this year, running at a rate 50 percent higher than the average since 2000 during the first three quarters, according to Standard & Poor’s.

And more may be coming as the fiscal cliff and its attendant tax increases loom, because buybacks aren’t a taxable event, writes Wall Street Journal columnist Brett Arends.

The argument for stock buybacks, aside from their lack of tax, is that they lower share count and thus increase the ownership stake of investors.

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.

Arends gives several guidelines for investors considering purchases of stocks of companies making buybacks.

First, make sure the companies aren’t overpaying for their stocks. Warren Buffett, whose Berkshire Hathaway is buying back shares, says he won’t do so if the stock is trading at more than 120 percent of net asset value.

Second, make sure a company’s share count is indeed shrinking. Often it won’t because the buybacks are outnumbered by share issuance to employees. And avoid companies that borrow to pay for their buybacks.

A strong argument can be made against buybacks in any case. Dividends put money in your hands, but there is no guarantee buybacks will do so.

Even if a buyback reduces share count and is done at a cheap price with surplus cash, there is no guarantee that it will make your share price go up.

Editor's Note:
Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop. 

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