Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Hewlett-Packard Company (HPQ), Weight Watchers International, Inc. (WTW), Alliance Data Systems Corporation (ADS): Don’t Be Fooled by These Destructive Buybacks

Returning capital to shareholders is usually interpreted as a shareholder-friendly action — and it often deserves this interpretation. However, the tendency of investors to view all returns of capital as positive events has emboldened the boards of struggling companies to initiate share repurchases as a show of confidence — even when such repurchases destroy shareholder value.

Hewlett-Packard CompanySuch value destruction occurs at companies with good and bad prospects alike. For instance, Hewlett-Packard Company (NYSE:HPQ) spent $17.6 billion on share repurchases in 2010 and 2011 just as the PC market started to show serious signs of stumbling. Although the repurchases boosted earnings per share, shareholders would have been much better off had the company paid out the money in a dividend. Instead, Hewlett-Packard Company (NYSE:HPQ) paid only $1.5 billion in dividends during the period and bought back stock at much higher prices than it trades for today, now that reality is priced into the stock.

But even good businesses with bright prospects can destroy shareholder value by repurchasing stock that is selling well above intrinsic value. Weight Watchers International, Inc. (NYSE:WTW) provides a good example of this. Weight Watchers International, Inc. (NYSE:WTW) has a strong brand and effective program that enable it to earn outsized profits year after year.

In 2007, the company borrowed money to repurchase $1 billion in stock at $54 per share. It increased its leverage once again in 2012 with a $1.5 billion repurchase at $82 per share. The stock currently trades around $45 per share due to uncertainty regarding near-term earnings.

Destruction not just obvious in hindsight

The vast destruction of shareholder wealth brought on by repurchases of Hewlett-Packard Company (NYSE:HPQ) and Weight Watchers International, Inc. (NYSE:WTW) stock is not only obvious in hindsight, it also should have been obvious at the time of repurchase.

Hewlett-Packard Company (NYSE:HPQ) traded at a decade-high $50 per share in early 2010, but fell to the low $40s as cracks began to appear in the PC market. Partial substitutes in the form of tablets and smartphones were clearly hurting PC sales, and it was clear that Hewlett-Packard Company (NYSE:HPQ) would at least not have any tailwinds if not headwinds. The last thing shareholders should want in a declining business is for management to reinvest cash, which is essentially what repurchases are doing.

In Weight Watchers International, Inc. (NYSE:WTW)’s case, reinvesting cash in the business is a good idea — but only at the right price. The company has demonstrated significant pricing power over the last two decades, and it is unlikely that even free Internet applications will derail the company’s profitability.

But Weight Watchers International, Inc. (NYSE:WTW) repurchased shares for $82 apiece in a year when the company earned a record $4.23 per share; it paid 19 times record earnings for a business that will grow at a slow-to-moderate pace over the next decade.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.