DOLLARS and SEN$E

BY CHRIS HANLY

Investment Consultant, Gary Goldberg Financial Services

Noise on dividends and buybacks has reached an almost fevered pitch since Apple‘s (AAPL) $100 billion cash hoard came to light. Accordingly, I thought some context and perspective on dividends and buybacks was in order. Some advisors, brokers, and investors believe that share-buyback programs are “always” a good thing. I am always distrustful of the word always, as it rarely seems to hold true. As with any other indicators, stock buybacks have to be put into context. Investors need to be careful and review many other pieces of information.

Foremost, at least from my perspective, investors should look at what will happen with the repurchased shares. In many cases they are used as executive compensation and stock option programs; in other words, they are re-circulated into the market. Take Alcoa (AA), one of the worst performing stocks among the Dow components over the last five years (Bank of America (BAC)–is the biggest loser, but let’s not pile on). Since 2006, venerable AA, buffeted by volatile commodity markets, has seen its revenue plunge from $30.3 billion in 2006 to 24.9 billion in 2011, while net income has been more than halved from $2.1 billion to about $810 million.  The operating margin has declined by more than four percentage points from 17.8 percent to 13.2 percent. By contrast, the best performing stock in the Dow, McDonald’s (MCD), has grown revenues over the same period from $21.6 billion to $27 billion, while net income has nearly doubled from $2.9 billion to $5.5 billion.

In 2007, Alcoa announced its intention to buy back as much as 25 percent of its own stock. While details about the number of shares purchased are sketchy, I think it’s safe to say that however many shares were bought, the action had little if any impact on the performance of the shares. On the other hand, shareholders of McDonald’s, whose last share buyback was announced 10 years ago, were rewarded almost exclusively on the skills and expertise of its management. To wit, even after running its restaurants for 57 years, management still managed to wring significantly more profit out of them as the operating margin rose about nine percentage points, from just under 27 percent to just over 36 percent years, during the last five years.

I bring this to your attention, because I often come across individuals who seem to have been misguided and only received part of the information necessary to make a smart investment decision. At a time when dividends and stock buybacks are all the rage, and markets are climbing a wall of worry, I urge you to take a moment and ask the difficult questions – is this company growing its business, do they have a strong management team, is the valuation attractive, etc… If you are uncertain of what to look for, feel free to call me – I would be pleased to meet with you and discuss how I might be of help.