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David Weidner's Writing on the Wall

March 22, 2011, 12:01 a.m. EDT

View all David Weidner's Writing on the Wall "º

"¹ Previous Column

Worse than Japan? Maybe our reaction

First Take "º

Verizon doesn't want Sprint

By David Weidner, MarketWatch

NEW YORK (MarketWatch) "” For the first time in years, investors are cheering the big banks. The latest round of stress tests are over, and dividends are back.

/quotes/comstock/10w!i:bkx BKX 51.71, -0.30, -0.58%

Forgive me if I don't share the excitement.

Sure, it's about time that BB&T Corp. /quotes/comstock/13*!bbt/quotes/nls/bbt (BBT 26.65, -0.23, -0.86%) , J.P. Morgan Chase & Co. /quotes/comstock/13*!jpm/quotes/nls/jpm (JPM 45.54, -0.09, -0.21%)  and U.S. Bancorp /quotes/comstock/13*!usb/quotes/nls/usb (USB 26.43, -0.17, -0.64%)  are allowed to reward shareholders for their patience and support. Those banks are well run and can afford the cost. Read more about the return of bank dividends.

But banks can never let a good thing just be a good thing. Enter the return of stock buybacks.

Buybacks allow companies to use their cash stockpiles to purchase their shares on the open market. The theory is that buybacks shrink the float and make each share worth more.

It is, however, just a theory. In reality, most buybacks don't work. In fact, if your bank is buying, maybe you should sell.

"Most companies have been too enthusiastic with their stock-buyback programs," Standard & Poor's concluded in 2007. They "have not increased shareholder value." See S&P summary of buyback study.

Theory vs. reality

Before we get into why buybacks are a waste of money, let's consider when they do work. Let's say Company X is trading at less than book value. There's worry about X's industry, but X has ample cash. It buys back 2% of its stock. Voila, the price-to-earnings multiple is higher, the momentum shifts, and the shares rise. It's a great story if it's true.

$( function() { embedPlayerByVideoId('{366E9266-5E6F-4427-A9E4-C61534695422}', 'video_366E9266-5E6F-4427-A9E4-C61534695422', '162', '287'); }); Oil prices spike on Libya attacks

Plus, Citigroup sets a stock split and resumes its dividend.

Here's what really happens. Company X's stock is stuck in the doldrums "” mostly because X can't show any meaningful profit growth. So, X announces and spends money on a buyback. The announcement sends shares up briefly, but then they continue to bump along. Any increase in the stock price is offset by cash used to buy shares or shares issued for compensation. If the stock goes down suddenly, Company X has made its situation worse.

OK, you say, that's your opinion. Yes, but consider someone who knows the game pretty well. His name is Warren Buffett. In an interview with PBS's Nightly Business Report in 2009, the head of Berkshire Hathaway Inc. /quotes/comstock/13*!brk.a/quotes/nls/brk.a (BRK.A 127,719, -57.00, -0.04%)   /quotes/comstock/13*!brk.b/quotes/nls/brk.b (BRK.B 85.21, +0.04, +0.05%)   gave his opinion on buybacks:

"If your stock is undervalued, significantly undervalued, management should look at [buybacks] as an alternative to every other activity," Buffett said. "That used to be the way people bought back stocks, but in recent years, companies have bought back stocks at high prices. They've done it because they like supporting the stock."

It's nice to see that Buffett and I are on the same page. But, you say, those are just opinions. Where's the evidence?

Page 1Page 2 Add Comment › · Recommend (4) · Post: Alert Email Print More David Weidner's Writing on the Wall March 15, 2011 Worse than Japan? Maybe our reaction March 7, 2011 Why you need to watch the Galleon case March 1, 2011 Wall Street's big mouths, bad bets Feb. 15, 2011 A week Wall Street won't forget Feb. 8, 2011 Meredith Whitney's muni-bond panic Explore related topics Computer Hardware Computer Software KBW BANKS BB&T Corp JPMorgan Chase & Co US Bancorp Comments Screener About David Weidner

David Weidner is the Wall Street columnist for MarketWatch. He formerly covered M&A and financial services at The Daily Deal, American Banker and Dow Jones. He writes the Writing on the Wall column which appears Tuesday on MarketWatch and Thursdays on WSJ.com. He also is a regular contributor to the News Hub.

First Take Verizon doesn't want Sprint

But the carrier, which noted it was built from acquisitions, may be looking at smaller cellular carriers to combat AT&T's proposed mega-deal with T-Mobile

45 min ago1:14 p.m. March 22, 2011

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"Deutsche Bank $DB finds a new risk in its derivative products. http://bit.ly/ghCtkE" 11:22 a.m. EDT, March 22, 2011 from davidweidner

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"If your bank is buying, sell. http://t.co/G6uR9tm" 5:56 a.m. EDT, March 22, 2011 from davidweidner

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