By James Saft
Feb 5 Based on its own history, and the broader experience with other companies, Apple's plan to buy back $60 billon of its own shares will probably end as a bit of a disappointment.
That's because companies on the whole buy their own shares badly, a generalization which Apple seems well on its way to fulfilling.
Under intense pressure from activist investor Carl Icahn to up that $60 billion by another $50 billion, Apple last week beat earnings and revenue estimates but managed to disappoint the market anyway, sparking a double-digit percent sell-off in its shares.
Apple's buybacks during the quarter were central to the story in two ways: first, they flattered earnings in a way only a sycophant would believe; second, they lost money anyway.
That second point should come as no surprise to students of corporate history, or for readers of a newly revised study by academics at the University of Kentucky which shows that, on the whole, executives do a worse job timing share buybacks than if they simply left the task to a robot.
First, let's talk about Apple in specific. While it beat estimates on earnings per share it did so only because $5 billion in buybacks during the quarter reduced the number of shares across which earnings must be shared. Good news you might say, but not good enough by a long shot to overcome concerns about sales in key products or about Apple's ongoing ability to create new needs among its consumers.
The net result was that Apple spent $5 billion in the quarter buying shares for an average of $523.50 per share, shares now worth just $512.59 each. Apple's P/E net of its $150 billion or so of cash is about 8, which the market evidently deems correct for a company struggling to grow its net income.
In contrast, Apple paid dividends of $2.7 billion in cash during the quarter, money which investors were free to re-invest or invest elsewhere as they saw fit.
According to the study, by Alice Bonaime, Kristine Watson Hankins and Bradford Jordan of the University of Kentucky, despite having presumably good information about the health and valuation of their own companies, executives carrying out share repurchase programs leave quite a bit on the table. ()
Unusually, the study compared the annualized rate of return of repurchased stock compared to what the company would have made had it simply made regular, identically sized repurchases.
Looking at 5,500 firms which bought back stock between 1984 and 2010, they found that while companies made an average annualized return of 7.66 percent, they could have bumped that up to 9.64 percent had they only closed their eyes and bought the same amount every quarter.
"Managers, on average, repurchase when prices are higher and would be better served by simply smoothing their repurchasing dollars more evenly across time," the authors write.
To understand why the people with such good information perform so poorly, you really have to consider that maximizing shareholders returns is not always at the heart of buyback campaigns.
But why do managers time things badly? One possible reason is to flatter earnings and allow managers to reach otherwise unattainable expectations. The study identified firms within the sample with an incentive to use buybacks to manage earnings and found something striking. Those with reason to monkey with the share denominator in order to meet expectations which they otherwise wouldn't underperformed in their timing of share buys.
The easy conclusion to draw is that managers seeking to flatter earnings are less concerned about whether they are getting a good price on their own shares with shareholder money.
Similar results were found with companies facing dilution because of the issuing of new shares. Given that executive compensation is a common reason for dilution we have evidence here of agendas which are not exactly serving well the widows, orphans and pension funds which own companies.
Interestingly, the study also found that smaller companies during merger waves often repurchase their own shares at sub-optimal prices as a means of staving off a takeover. Now, I have my doubts about the value of many takeovers, but I am guessing that the executives are giving at least some thought to the reality that they would be out of a job if their company were bought.
To be clear, I have no idea about the motivation of Apple executives. Carl Icahn, a smart guy if ever there was one, thinks buybacks are a good idea, and it is certainly true that Apple's cash pile needs addressing in some way.
On the whole, however, I think I'd prefer dividends.