It was recently announced that General Motors would buyback all of its $2.1 billion worth of shares of its preferred stocks from the (Shepardson, Oct 28, 2010, DetNews.com). This announcement comes just weeks before the scheduled initial public offering is set to begin for the company.
Upon this initial hearing, this may seem like positive news… well, why not? Studies have shown that the market typically reacts optimistically to a firm’s repurchasing announcements. In fact, this move by GM would mean that the future sale of the preferred stocks- which would convert to common stock- would be used to reduce its debt and apply badly-needed capital to its underfunded pension and health care plans (Shapardson).
However, like all things that sound good, further investigation must be pursued. While these studies show that market behavior usually has positive knee-jerk reaction, these same studies only indicate this when the stock markets are high (when it’s an efficient market, if you believe in such efficiency).
Which leads to this question: Are stock repurchase plans beneficial to investors or not?
There are several factors on why a firm repurchases stocks, like: to increase return on equity, the belief that the stock is undervalued in order to increase demand, used as a method of cash distribution for stockholders, the company feels that it is its own best investment at the time, or it’s simply a tax decision. With this said, buybacks are generally applied when there is temporary cash-on-hand.
What does this mean to you, the investor?
Companies (for the long-term) may not feel as confident in its financial future as the market would imply (for the short-term). What do I mean by this? The market is-albeit temporarily- positively reacting to what management could view as a not so brightly-lit future.
I’d equate this notion to “borrowing” my children’s allowance in order to buy them presents and not having any idea as to how to pay them back. Sure they’re happy for the moment but wait until they find out I used their money to buy those gifts.
However, let’s not jump to immediate conclusions yet. With the reasons previously given for a firm to buy back stocks, keep in mind, repurchases can still be a move in the right direction for investors.
So, to answer the question posed as to whether or not stock repurchases benefit investors. The answer: it depends. It depends on how management chooses its investment objectives. The decision for GM to buy back its stock for the purpose of restructuring after coming back from a government bailout, an 18 month bankruptcy, and public scrutiny is a good thing.new plan of action is “aimed at getting its balance sheet in order ahead of its planned stock sale” which can all indicate positive measures towards financial stability (Shepardson).
As far as for the investor it depends on your own levels or ideas of success. Are you focused on short-term or long-term success? An objective for the investor is just as important for the corporation with the additional understanding that markets may not be as short-term as some studies have shown. So with that said, by having a clear understanding of the motives behind the actions of the firm, in terms of share repurchase, investors can very well benefit from it.
Note: Report originally written November 8, 2010. Not posted until November 18,2010.
- Good Buyback, Stupid Buyback (SBUX, TNAV) (247wallst.com)
- RightNow Announces Increased Stock Repurchase Program (eon.businesswire.com)
- Mattel Increases Buyback After Icahn Takes Stake (forbes.com)
- Repurchase Mania: The Top 10 Buyback Stocks (dailyfinance.com)