A Bigger Slice of the Profits

What do ExxonMobil, Goldman Sachs, Harley-Davidson and IBM have in common? Each has a healthy appetite for its own stock. In fact, all of corporate America seems to be feasting. In 2005, U.S. companies announced a record $458 billion of stock buybacks on the open market. The banquet is still going strong in 2006, with 108 buybacks worth $66 billion announced so far. By buying their own stock with spare cash, companies are signaling that the shares are a good value at the current price. The large volume of buybacks hints that the broad market is undervalued. And with fewer shares trading, remaining shareholders get a larger ownership stake -- a bigger slice of the earnings pie.

But the truth about buybacks is more complex. Despite record buybacks, the aggregate number of shares outstanding of companies in Standard & Poor's 500-stock index is rising, says UBS Securities, primarily because companies have been issuing so many stock options to executives and employees.

You can find the money spent on buybacks in a company's cash-flow statement. But the income statement is where a company's share count is compared from year to year. Between the two, you'd find, for example, that Yahoo spent nearly $1 billion to repurchase shares last year, while the number of shares outstanding rose 2%. ConocoPhillips spent $1.9 billion, but the number of shares increased 3%.

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Still, 80 firms have decreased their share count by at least 4%, including Exxon, Goldman, Harley and IBM. If you own stock in a firm that really does reduce its share total, the buyback can pay off. A portfolio equally weighted with companies that have positive earnings trends and share-count reductions of 2% or more, rebalanced quarterly, would have returned nearly 20% annually since 1984, compared with 13% for the SP 500, says Lehman Brothers.

Still, you need to be clear on the rationale behind a buyback. Has a temporary cloud put the stock in the bargain bin? Then a buyback -- especially if executives are buying for their own accounts -- is bullish. Similarly, in a maturing industry or slowing economy, buybacks are a legitimate way to boost the return -- more promising, for example, than using the cash for doubtful expansions. Altria is the poster stock here. Since 1989, the former Philip Morris has trimmed its share count by 2% annually and increased earnings per share more than 10%.

Expect buybacks in general to remain popular this year. The motivation won't so much be issuing stock options; companies are actually issuing fewer of them due to restrictive accounting rules. Rather, more companies will use repurchased shares as a war chest for acquisitions. And more seem committed to simply serving up a bigger slice of the pie. Yum.