Shareholders and investors of two blue-chip companies were treated to good news on Monday July 9, 2007, that carries potentially bullish long-term consequences.
First, Johnson & Johnson announced the repurchase of up to $10 billion of its common stock.Then ConocoPhillips announced the repurchase of a $15 billion share buyback programme, representing an increase of $13 billion above the $2 billion that remained in a previous buyback program.
But why is a buyback programme a positive sign for investors? Why would a repurchase carry such bullish potential? One explanation is in terms of simple supply and demand: Repurchases reduce the supply of a company's outstanding stock, which should increase the price of those shares that remain.
Another explanation is that companies that repurchase their shares are so confident about their future prospects that they are willing to commit corporate resources to buying them. This is worth paying attention to, since a company's executives and Board of Directors have access to insider information that the rest of us do not.
Like such, repurchase programs are analogous to corporate insiders purchasing their companies' shares for their own accounts. Both signal confidence in the company's future prospects which again is a bullish signal.
In a nutshell:
When a company reduces the amount of shares outstanding by declaring a stock buy back program, each of the shares becomes more valuable and represents a greater percentage of equity in the company.
So when putting together your portfolio, you could seek out strong and solid companies that engage in these sorts of pro-shareholder practices and hold on to them as long as the fundamentals remain sound.
One of the best examples is the Washington Post, which at one time was only $5 to $10 a share. It has traded as high as $650 already. That what I call long-term value!
But be aware! Even though buy backs can be huge sources of long-term profit for investors, they are actually harmful if a company pays more for its stock than it is worth. In an overpriced market, it would be foolish for management to purchase equity at all, even in itself.
Instead, the company should put the money into assets that can be easily converted back into cash. This way, when the market swung the other way and is trading below its true value, shares of the company can be bought back up at a discount, ensuring current shareholders receive maximum benefit. Remember, even the best investment in the world isn't a good investment if you pay too much for it.
