Buybacks Lag, Squeeze Looms For Earnings

By SCOTT PATTERSON

January 24, 2007; Page C1

(See Corrections & Amplifications item below.)

The buyback binge shows signs of burnout.

Corporations have been gobbling up their own shares for more than three years. Hefty cash flow and cheap debt made it attractive for companies to repurchase previously issued stock, which in turn helps to increase earnings per share by reducing the number of shares outstanding. But according to estimates from Standard & Poor's, buybacks haven't increased since last spring.

[Chart] Share buybacks more than tripled from 2003 to 2006, rising to an estimated $437 billion from $131 billion, according to S&P. That is roughly enough money to buy all outstanding shares of Exxon Mobil, the world's largest company by market value.

Exxon itself was at the head of the line in the buyback binge, having repurchased 42.3 million of its shares in the 24 months through the third quarter of 2006, according to S&P. Microsoft was No. 2, buying back 34.6 million shares. Procter & Gamble, Citigroup and Intel rounded out the top five.

The buybacks have given companies a big boost. In the first three quarters of 2006, 27 cents of Caterpillar's $4.01 of per-share earnings were the result of buybacks, according to Birinyi Associates. J.P. Morgan Chase got an 18-cent lift on $2.80 earnings per share; Exxon got a 29-cent boost on $4.90 earnings per share. Since the current bull market started in 2002, 29 of 30 companies in the Dow Jones Industrial Average have seen a positive impact on per-share earnings from buybacks. The lone standout: General Motors, which doesn't have an active buyback program.

That might be changing. In the fourth quarter, buybacks by S&P 500 companies were up an estimated 5.6% from the previous year. That was well below the average year-over-year increase of 54% for the previous 12 quarters. The total dollar amount of buybacks in the fourth quarter -- estimated by S&P at $110 billion -- was down from record second-quarter 2006 buybacks of $117 billion.

The stock-market rally in the second half of the year might have made companies less eager to buy shares at elevated prices.

Of course, buybacks could rise again. Corporate executives are under great pressure to keep their share prices rising. But the latest pause is a timely reminder that buybacks can't keep surging forever. The earnings boost they have given companies can't either.

Investors Unwise to Bank on Billions From Beijing

Wall Street is licking its chops about another potential customer for U.S. stocks: the People's Republic of China.

In a speech Saturday, Premier Wen Jiabao said China would "actively explore and expand the channels and methods for using foreign-exchange reserves."

In a research note, Bank of America strategist Thomas McManus says China could create an investment institution similar to Singapore's Government of Singapore Investment Corp., and funnel hundreds of billions of dollars into assets world-wide, including U.S. stocks.

Investors ought to be very wary of predictions about how China will manage its money. The Chinese government has shown with the management of its currency, the yuan, it will write its own script, and leave everyone else guessing.

Write to Scott Patterson at scott.patterson@wsj.com1

Corrections & Amplifications:

Exxon Mobil Corp. repurchased $42.3 billion of shares in the 24-month period through the third quarter of 2006, and Microsoft Corp. bought back $34.6 billion during that period, according to Standard & Poor's. This column incorrectly said that Exxon repurchased 42.3 million shares and Microsoft bought back 34.6 million shares in the 24 months.

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Questions:

1.) What is a stock repurchase? According to the article, what was a primary motivation for executives to buy back shares in their own companies?

2.) What is meant by the term "Signaling"? Could a repurchase be motivated by an executive's desire to signal the firm's value? Support your answer.

3.) What effect does a repurchase have on a firm's capital structure? Does it the effect differ for repurchases that are financed by cash rather than by issuing additional debt? Support your answers.

4.) Should the increase in EPS from a repurchase change the price of the stock? Why or why not?

5.) What effect should the recent stock market rally have on the pace of repurchase activity? Support your answer.

6.) If firm has excess cash it wants to distribute to shareholders, what are the factors it should take into account in deciding between a repurchase, a one-time special dividend, and an increase in its regular dividend?