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Don’t Trust Buybacks

CNBC.com
Tuesday, 7 Aug 2012 | 6:43 PM ET

Cramer used to be a big fan of companies who repurchased their shares on the open market. He thought they were a good way to reward shareholders because the buybacks boosted the stock price. But a lot of these deals haven’t returned the value he thought they would, and in some cases they’ve been “a gigantic waste of corporate money,” he said.

Since the crash of 2008 there have been a number of companies that bought back their stock at higher prices, leaving shareholders with nothing to show for the billions spent doing it. The health-maintenance organizations might be the worst offenders. Instead of paying dividends, Aetna, WellPoint and Unitedhealth Group used that money to finance massive buybacks — even though in some cases insiders were selling at the same time.

In the end, the buybacks did nothing for the stocks. And what’s worse, they left on the table what would have been yielding more than 4 percent if these companies had poured the money into dividends. That’s the level at which all dividend-paying companies become more attractive to investors, Cramer said, and a flurry of buying might have provided the share-price support they had originally wanted.

So why do CEOs like buybacks so much? Remember, a company’s earnings-per-share is its net income divided by the total number of shares. So the repurchase of stock is a cheap way to boost the EPS.

Also, CEOs often try to call a bottom in their company’s stock by announcing a buyback. But this shows a lack of understanding of how the market works, because the share price will continue to plummet as long as the business is in decline.

Cramer dispelled the myth that buybacks can cushion a stock’s fall in a bear market. Unfortunately, short sellers these days wield too much power, enough to overwhelm even the most well-intentioned company. Especially because there are rules about how much stock a company can buy back on a given day. Meanwhile, the regulations that used to keep short sellers in check disappeared while Christopher Cox was running the Securities and Exchange Commission.

In sum, you never want to own the stock of a company that’s wasting the money it needs to survive on useless buybacks. Or worse, spending money it doesn’t have on them. And never rely on even the largest repurchase plan to help prop up a stock.

“The way I see it,” Cramer said, “from now on, buybacks [are a] false sign of health and too often a waste of shareholders’ money.”

Written by Tom Brennan; Edited by Drew Sandholm

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

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