Last year (2013) was a time of significant corporate stock buy-backs. Corporate management used about $750 billion (some of which was borrowed at historically low interest rates) to repurchase shares of their company stock. The last time such levels of buy-backs were done was in 2007—remember what happened in 2008? Buy-backs reduce the number of corporate shares outstanding in the market; therefore, the earnings per share of the company increases. Given that stock price/earnings multiples have increased from 14 times to 16 times in 2013, the net impact of stock buy-backs has produced some very favorable results for corporate incentive packages paid to management. Increasing earnings per share is a good thing is it not? That depends.
The prudent investor should determine why corporations are pressuring buy-backs. Corporate management may have these concerns:
- Slow growth in the economy does not justify spending corporate cash in expanding operational capability.
- A declining demand for corporate products has occurred.
- No better available alternatives may exist for investment (in the opinion of corporate management).
The return of cash to investors may occur because the corporate management worries about the general economic growth in the coming years, a particularly troubling possibility in light of the stock market increase in 2013.
Of course, management may have felt that investment in their shares was appropriate and that their stock was undervalued at current market levels. Many things must be considered in making an investment decision. We at Paragon Financial Advisors help our clients analyze the investments that may be appropriate for their investment goals.
If you have unanswered questions about corporate stock buy-backs or need additional guidance please call us. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management services for our clients.