Stock Buybacks: An Investor’s Friend or Foe?

I'm betting you've reined in your spending during the recent economic
recession and continuing uncertainty plaguing global economies. Our household
certainly has! But even with the reduction in consumer spending in the past few
years, it's a sad fact that most households have seen their net worth fall.
According to the Federal Reserve, during the third quarter of this year,
Americans saw their net worth decline about $2.4 trillion primarily due to
dropping values in our homes as well as in our investments. But on the corporate
front, things are much brighter … As you've undoubtedly heard and read
about, corporations have come out of the recession a lot better than households.
They were smarter this time around cutting costs very early, which has served
them well. Corporate profits have been heading up for the past year and,
according to Thomson Reuters, rose 17.9% in the third quarter. And instead of
rushing out to spend that extra money, America's businesses have been hoarding
their cash. Still rising some 28% of assets now corporate cash and equivalents
stand at about $2.12 trillion, according to the Federal Reserve. Traditionally,
companies use their cash in five ways: Cash reserves Product/business expansion
Mergers and acquisitions Dividends Buybacks While they are keeping their cash
reserves high, companies have been very timid at business expansion in the past
couple of years. We are beginning to see more money flowing into R&D, and M&A is
picking up. Theres been about $2.22 trillion in transactions so far this year
roughly the same as 2010, according to Bloomberg, but we have yet to see a
barn-burning run to build business. Instead, companies in the S&P 500 Index have
been putting their cash to use primarily in two ways: By increasing their
dividends By rushing to buy back shares So far this year, companies in the index
have increased their dividends by about 10%, which has been a nice bit of extra
change to many investors. But the buyback trend is much more pervasive. In the
second quarter of 2011, S&P 500 companies spent $109.2 billion buying back their
shares a rise of 21.6%, and the eighth consecutive quarterly increase in stock
buybacks. Year-to-date, more than $454 billion in stock buybacks has been
authorized the most since the 2007 peak of repurchases, at $914 billion,
according to Birinyi Associates. Companies buying back their shares this year
include IBM (NYSE: IBM ), Pfizer (NYSE: PFE ), Dell (NASDAQ: DELL ), Disney
(NYSE: DIS ), Lowes (NYSE: LOW ), Coca-Cola (NYSE: KO ), Goldman Sachs (NYSE: GS
), DuPont (NYSE: DD ), Navistar (NYSE: NAV ), Intel (NASDAQ: INTC ) and Amgen
(NASDAQ: AMGN ). Even Warren Buffett's Berkshire Hathaway (NYSE: BRK.B , BRK.A
) has jumped on the bandwagon. Sounds good, doesn't it? After all, by reducing
the number of shares outstanding, the earnings of a company are distributed
among fewer shares, so earnings per share effectively rise. And investors love
it when earnings increase no matter the cause and often reward a company by
sending its shares higher. But astute investors need to look behind the scenes
to determine if share buybacks are good for investors in the long run.