Is a Buyback Worth the Price?

With the iPhone 5 making its official debut this week, it looks like another good week for Apple, and especially for Apple shareholders. And in addition to the new phone, there’s more good news on the way for investors: Apple has announced a stock repurchase of around $10 billion to begin later this month. The official explanation is that Apple will be buying up shares to cover some recent dilution due to executives exercising options, but it will likely have a positive effect on Apple’s stock as well — as if it needed it.

The logic behind stock buybacks is that they signal that the company has confidence in its own ability to grow the business, but there is a concrete benefit as well. With fewer shares outstanding, the value of each individual share on the market increases in value. Or so the theory goes.

That’s a part of why Facebook’s planned buyback of its beaten-down stock is such good news for its shareholders. The purchase was announced in sort of a backward way — Facebook planned to pay some taxes owed to the IRS with the use of the repurchase program — but the message was clear: Management thought the stock was undervalued, and is prepared to put its money where its mouth is. In the case of a stock that’s been crippled like Facebook’s has, management confidence is a very good sign.

So there are two primary ways for these repurchase programs to benefit shareholders. But in the recent history of buybacks, both in the larger market and in the tech sector, the theory hasn’t always held out.

Consider the electronics retailer Best Buy, which has bought back 98 million of its own shares since April 2010, according to the Wall Street Journal’s CFO Report. It paid about $30 a share for that stock, but it’s now trading just under $20, which means the buyback program has cost Best Buy around $1.2 billion.

That’s not unheard of for buyback programs. Like many individual investors, companies are all too often willing to buy their own stock when prices are high, and sell it when prices are low. In the recent past, stock buybacks by the S&P 500 peaked at $172 billion in the third quarter of 2007 — when the market was at its peak – and reached a trough at $24 billion in the second quarter of 2009, just after the market had hit bottom in March of that year.

Even if the repurchased stock doesn’t fall in value, it can often end up just being misleading for investors. To take one example, Cisco reported earnings per share of 36 cents in its latest quarter, which was apparently an increase from the same quarter two years earlier, when Cisco earned 33 cents per share. In reality, Cisco’s net income actually dropped by $18 million over that time frame. But the EPS numbers looked strong because the stock buyback reduced the number if shares outstanding. Intel and Microsoft can tell a similar story.

But if the company buys up enough shares, it can really have an impact on the stock price. The online health insurance company eHealth has already bought back 21 percent of its outstanding shares, and has just announced plans to buy 10 percent more. The company’s share price is up more than 14 percent on the year.