U.S. Companies’ Contrary Indicator for Stocks: General Electric Company (GE), 3M Co (MMM)

After setting a new all-time nominal high on the Dow, stocks added to their gains today as the S&P 500 and the price-weighted Dow Jones Industrial Average advanced 0.1% and 0.3%, respectively.

Despite a new high on the Dow, the VIX Index, Wall Street’s fear gauge, was slightly higher on the day, closing at 13.53. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

Buy ‘em
Research firm Birinyi Associates published a note this morning, with some data that is consistent with the buoyant mood of a stock market that is close to setting new all-time nominal highs (I say “close to” because I’m waiting for the S&P 500 to confirm the Dow’s milestone):

We recorded $117.8 billion in buyback authorizations during the month of February, representing a 103% gain over the same period in 2012 ($118 bln vs. $68 bln). February was the largest month, in dollar terms, on record.

We know individual investors are still not much for equities right now, but companies, apparently, are. However, while stock buybacks may continue to contribute momentum to this bull market, it’s not a reassuring indicator as far as value and long-term returns are concerned, as Birinyi’s next observation suggests:

We are currently on a run-rate to log $827 bln of authorizations in 2013 vs $477 bln in 2012. 2007 was the only year in our database where we recorded more ($863 bln).

Unfortunately, due to a combination of bad incentives and ignorance, treasurers, company finance executives, and executive boards do a spectacularly bad job when it comes to implementing share repurchases. The following graph, which spans the fourth quarter of 2002 through the third quarter of 2010, illustrates the problem. The blue bars represent the quarterly share buybacks of S&P 500 companies (in billions of dollars, left axis) and the black line represents the quarterly average value of the S&P 500 index (right axis):

To summarize: As long as share prices are going up, companies are happy to buy them in increasing amounts; when shares get cheaper, they prefer to buy them in smaller sums. That makes no sense from the perspective of a value investor. Which are some of the names to scrutinize right now? According to Birinyi Associates, of the top five largest repurchase authorizations through the end of February, three are members of the Dow: The Home Depot, Inc. (NYSE:HD)General Electric Company (NYSE:GE) and 3M Co (NYSE:MMM). That doesn’t mean the shares are necessarily overvalued, but it certainly invites scrutiny.

The article U.S. Companies’ Contrary Indicator for Stocks originally appeared on Fool.com and is written by Alex Dumortier, CFA.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on LinkedIn. The Motley Fool recommends 3M and Home Depot, and owns shares of General Electric.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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