According to Graham & Dodd's Security Analysis: "[A] company which buys and sells its stock advantageously, thereby increasing both the book value per share of the remaining shareholders and, in particular, the earnings per share, has an attraction that goes beyond the basic earning power."
A stock buyback plan can change the overall perception of a company, which becomes seen as one that is willing to spend its own money to repurchase outstanding shares. The size of an individual company's stock buyback can make a difference in the reaction from the investment world. A stock buyback of 6% to 8% of all outstanding shares, for example, can make investors take notice, while a buyback of 10% or more is often perceived as a screaming "buy!"
Stock-buyback programs have two sides to the story. Some view a buyback program negatively, as skeptics believe the company is lacking in better ideas for which to use the excess cash. Others view buyback programs in a positive light, as management believes that the company's stock is a strong buy at current prices. A key point to prioritize is the percentage of shares that are being purchased rather than the absolute dollar amount.
In the second quarter of 2007, IBM announced plans to repurchase $40 billion worth of its common stock by 2010, equaling previous buybacks in 2001 and 2006. In the second quarter of 2007 alone, IBM repurchased $15.7 billion. In fact, IBM is among the leading names when it comes to buyback activity.
During the 3-month period when IBM scooped up $15.7 billion of its own shares, the stock rallied nearly 12%, and continued to build on this strength into the second half of the year, rallying beyond a new 5-year high. This performance allowed Big Blue to handily outperform its fellow large-cap technology shares, and some of its strength was likely due to buyback activity.
Like other sentiment, technical, and fundamental indicators, buybacks should not be the sole reason for jumping into a stock position. The point of Expectational Analysis® is to compare and contrast a number of indicators, gaining a broad look at the full picture and proceeding from there. The fundamental implications of a stock buyback are merely one more thing to consider when picking stocks.
Stock splits are another aspect of fundamental analysis that can be used to gauge the perceived health of a company. A stock split occurs when a company decides to effectively increase the number of shares available for public trading by adjusting the underlying price of the stock. By shifting the share price, the market capitalization remains the same. Ratios of 2-for-1, 3-for-1, and 3-for-2 are the most common, but any ratio is conceivably possible, dependent upon the company's goals.
For example, if stock XYZ is trading at $90 per share with 1,000,000 available common shares of stock, its market capitalization would be $90 million. Splitting its stock 2 for 1, there would now be 2,000,000 shares of stock, each shareholder holds twice as many shares, the price of each of which is adjusted to $45. The market capitalization remains the same at $90 million.
While stock splits do not necessary beget higher prices, the announcement of a split in itself is usually the result of strong price action in the underlying shares. And while splits do not guarantee a continued uptrend, they do improve liquidity. Not only does a split put more shares on the market, but a lower-priced stock can be more appealing to a broader range of investors. A small-time investor will more likely be interested in a $50 stock than in one costing $100.
There are also reverse stock splits, which are clearly the direct opposite. A reverse stock split comes in ratios such as 1-for-2 or 1-for-3 and reduces the number of shares available for public consumption. Companies sometimes initiate a reverse stock split in order to effectively raise their stock price, reducing the risk of being delisted by stock exchanges or ignored by mutual funds.
For example, if an investor owns 5,000 shares of a $10 stock, the total investment is worth $50,000. After a 1-for-2 reverse stock split, for example, that trader will now own 2,500 shares of a $20 stock. Like a regular stock split, a reverse stock split does not increase the company's market cap. In this example, the total investment is still worth $50,000, but the price per-share is higher (and perhaps more palatable). Basically, the company hopes that the higher stock price will make it look better, encouraging more investors to purchase the stock. If this happens, the stock price will then rise as demand increases.
In many cases following a reverse stock split, however, the stock price will actually decline, and there has been some academic research proving as much. This is partially because a company finding the need to issue a reverse stock split is probably in difficult straits to begin with. On the flip side, there is evidence that small-capitalization equities that undergo a reverse stock split benefit from the split, having artificially boosted their stock price into a range that appears more acceptable to traders.