Losing Money by Buying Stock Back

By FLOYD NORRIS

BUY high. Sell low.

For your average investor, that is a recipe for disaster. But for companies, it has actually been a way to improve reported profits even as the cash flows out the door.

One such company is Dell, which announced this week that it was temporarily calling off its share repurchase program while it dealt with investigations of its accounting by the Securities and Exchange Commission and the Justice Department.

That blow was just the newest one for Dell. Its profits are down, the batteries in its laptops are being recalled and now the company thinks its old financial statements may be wrong, but is not sure how important the problem is.

Its stock this week traded for less than half the price it fetched in the summer of 2005.

The company did not say why it was suspending the program, and perhaps it will be reinstated after it gets its accounting in order. But Dell’s suffering shareholders have reason to hope the company will cancel it.

That is not conventional Wall Street wisdom. The accepted view is that stock buybacks raise earnings per share and support the share price. American companies have been repurchasing shares at a record pace, spending more than $100 billion a quarter.

There is no question that shareholders who sell to the company have reason to be happy. The remaining shareholders, however, may see it differently. To them, buybacks should be good news if the price turns out to be low, and bad news if the price is high. In other words, shares should be viewed like any other asset.

Measuring that performance is not as easy as it might be. The accounting rules provide that companies should not record profits or losses on transactions in their own shares, so a buy high-sell low strategy does not affect reported profits.

Dell’s record as a market timer is poor. It got so enthusiastic in 1999 and 2000, when the stock price was soaring in the technology bubble, that it not only bought back a lot of stock but also entered into complicated options transactions that committed it to buy shares in the future at prices that now seem very high.

The result was that in 2001 and 2002, when the stock price was in the tank, Dell was committed to buying shares not at the newly discounted price, but at the old price it contracted for when it entered into the options deals. The result: In the fiscal year that ended in January 2003, Dell’s average cost of share repurchases was $45.80 a share, even though the shares never traded as high as $32 during the entire year.

That embarrassed the company, and late in that fiscal year it bought its way out of the contracts. It probably would have done better to hold on, because the stock did well in the next year. That merely reinforced Dell’s reputation for bad market timing.

But by last year, its confidence was back. Dell shares were trading in the high $30’s, and sometimes topped $40. The company plowed $7.2 billion into share repurchases — more than twice its net income — only to see its business go into decline, taking the stock price with it. Yesterday, it closed at $21.61.

In the first two quarters of the current fiscal year, it spent at a slower rate, in large part because the price was down. And now it has, at least temporarily, halted purchases.

The money here is very real, by the way. During the last eight full fiscal years, Dell reported net income of $17.9 billion — and it spent $24.1 billion buying back stock.

Some of those repurchases went to reducing the share count. But most of them were purchased simply to offset the dilution caused by executives and employees cashing in stock options. I estimate that to buy the 491 million shares Dell issued for options over that period, it spent $10 billion more than it received from the options holders.

Those who oppose treating the value of options as an expense argue that no cash changes hands, and that the fair accounting treatment is to reduce earnings per share through the dilution that comes from more shares being outstanding. But, as Dell’s history shows, that ignores the cash cost from offsetting the dilution by repurchasing shares.

There have been companies that did wonders for their investors by repurchasing shares, as Teledyne did in the 1960’s and 1970’s under the direction of Henry E. Singleton. But he was also a brilliant investor who understood values. And unlike many current executives, he was not selling his own stock while the company was buying.

Unfortunately, many corporate boards are subject to the same emotional swings that affect investors. In good times, there is plenty of cash and they are willing to buy stock at high prices. When times get tough, the price falls and they cut back. That is a recipe for buy high-sell low.

Even if the accounting hides the results, that is never a good policy.

Home

World U.S. N.Y. / Region Business Technology Science Health Sports Opinion Arts Style Travel Jobs Real Estate Automobiles Back to Top