We identified the chance for private equity financed, management buyouts of megacap companies as a catalyst that could finally lead to megacap outperformance. Another potential catalyst is the increasing number and size of share buybacks by the country's largest companies. An optimist might characterize buybacks as a step short of a full-scale transaction.
Ian McDonald in the Wall Street Journal reports that U.S. companies are spending record amounts buying back their own stock. This is already on top of what had been record buybacks last year. Unfortunately some analysts are of two minds on the value of these buybacks.
These buybacks are sending mixed signals as the U.S. and world stock markets are jogging lower amid a host of economic worries. On one hand, large-scale stock buybacks reflect companies' desire to bolster their stock prices and corporate chieftains' belief that their shares are underpriced. Investors generally like buybacks because, all other things being equal, they increase the value — and usually the price — of the remaining shares.
On the other hand, by buying their own shares, companies are signaling that they don't see any better investments. "When buying back your own stock is the best use of capital, where are the long-term growth opportunities?" asks Byron Wien, chief investment strategist at hedge fund Pequot Capital Management, which has about $7 billion under management.
Adam Warner takes a more jaundiced view of the buyback wave. Unfortunately for many companies these buybacks do little to reduce shares outstanding. Indeed they only serve to sop up the shares issued due to option grants to management. According to Adam these buybacks amount to little more than a "…backdoor way to pay higher salaries, plain and simple."
On the margin share buybacks can help, but they are clearly inferior to full-scale corporate mergers and acquisitons. In short, be wary of managements that tout their share buybacks as shareholder friendly if they do little more than shift compensation from form to another.
