Share Buybacks and Business Fundamentals

When I select stocks, I consider a number of factors including valuation, financial condition, management quality, and attention to sustainability.  When assessing the management, I like to see a protecting the interests of existing shareholders by emphasizing per share measures, rather than just overall growth in the company's revenues or operating profits (which can come through acquisitions rather than inherent growth).  I particularly dislike large increases in the share base for acquisitions, as many acquisitions ultimately prove to be a poor use of capital.  Conversely, I like companies that repurchase their shares with excess cash generated by business operations--or with debt if  balance sheets are strong and the shares are exceptionally depressed in price.

But there are exceptions, and that is why one should use a variety of criteria when choosing a stock.  Share buybacks reduce the number of shares outstanding (and increase earnings per share) all else equal, but one must not lose track of the company's underlying business prospects.

A good example is Best Buy.  This once-dominant retailer of consumer electronics products has repurchased approximately 25% of its shares over the past five years.  That was probably a much better use of cash than if it had been used to expand its store base or acquire other companies.

During this time, however, technological changes have severely impaired the company's business prospects.  The stock is down 53% over the past year as earnings estimates for the latest quarter went from $.50 to an actual break-even quarter.  Cash generation (a crucial factor for stock selection) plummeted from $2.6 billion a year ago through nine months to only $81 million this year.  Since capital spending this year has been $522 million, the company has spent far more than it generated and indicates a severe weakening of its financial condition.

The remarkable deterioration at Best Buy is reflected in a depressed valuation.  It's p/e ratio on this year's earnings estimates is only 5.  I like out-of-favor value stocks where management shrinks the share base, but the alarming deterioration in the fundamentals and finances at Best Buy mean that investors should shop elsewhere.

Steve Lehman
LehmanInvest.blogspot.com/

BBY:  $13