Submitted By pluggplugg
eneral, markets have applauded such moves, making buybacks an alluring substitute if improvements in operational performance are elusive. Yet while the increases in earnings per share that many buybacks deliver help managers hit EPS-based compensation targets, boosting EPS in this way doesn't signify an increase in underlying performance or value. Moreover, a company's fixation on buybacks might come at the cost of investments in its long-term health.
A closer inspection of the market's response to buybacks illustrates these risks, since some companies' share price declined — or didn't respond at all. For example, Dell's announcement earlier this year that it would increase its buyback program by an additional $10 billion didn't slow the decline of its share price, which had begun to slide because of worries about operating results.
Buybacks aren't without value. It is crucial, however, for managers and directors to understand their real effects when deciding to return cash to shareholders or to pursue other investment options. A buyback's impact on share price comes from changes in a company's capital structure and, more critically, from the signals a buyback sends. Investors are generally relieved to learn that companies don't intend to do something wasteful — such as make an unwise acquisition or a poor capital expenditure — with the excess cash.
EPS May Be Up, but Intrinsic Value Remains Flat
Many market participants and executives believe that since a repurchase reduces the number of outstanding shares, thus increasing EPS, it also raises a company's share price. As one respected Wall Street analyst commented in a recent report, "Share buybacks...improve EPS, return on equity, return on capital employed, economic profit, and fundamental intrinsic value." At first glance, this argument seems to make sense: the same earnings divided by fewer shares…...