The recent announcement by Toys 'R' Us that it might repurchase $1 billion of its own shares raises an interesting question: When a company starts buying up its own stock, does that mean you should, too? Not necessarily, say the pros. Although buybacks are generally bullish, they are not clear buy signals.
When companies accumulate their own shares, the price often rises as the pool of available stock shrinks. It can be a signal that management sees the company as a good investment. But companies repurchase shares for a host of reasons--not all of them positive.
FALSE ALARMS. In the 1980s, many buybacks were attempts to ward off takeovers, and more recently, ailing drug and consumer-goods companies have bought back stock to prop up the share price. Still others, such as Merrill Lynch, which announced a $300 million buyback last month, are merely meeting employee stock-option and incentive obligations.
Another glitch is that companies often plan buybacks but don't follow through. "After the '87 crash, myriad companies announced buybacks," says Bob Gabele, president of CDA/Investnet in Fort Lauderdale, Fla., which tracks insider stock ownership. "When the dust settled, many never bought the shares they said they would."
Experts agree that you must know a company's fundamentals before news of a repurchase can be evaluated. Even then, "the buyback factor should only rarely come into the stock-selection process," says Lazlo Birinyi, whose Birinyi Associates tracks repurchases.
Bearing this in mind, there are clues to help you interpret buyback plans. "If insiders are buying, usually it's for the profit motive," says Gabele. "They think the stock will go up." But to use this information, which is available in data bases and periodicals, you must know if the stock is relatively low or high. "Try to buy at the same price as the insiders," he says. "If it has moved up, be patient. There's always another bust." Toys 'R' Us announced at about $39; the low for the past two years has been near 30.
RED FLAG. If they're selling, ask why. It may just be execs cashing in options. Other times, selling can tell you more than buying. "Managers tend to be optimistic about their own companies," says Richard Hoey, chief economist at Dreyfus. "So selling is more indicative" of trouble brewing.
Look for "strong cash flow in relation to capital-expenditure needs and little or no debt," says Tulsa money manager Frederick Russell. For example, H&R Block plans a $10 million buyback. Because it has lots of cash income and little overhead, he says, it clearly will be able to follow through. The issue is, will it?