Share buybacks worth scrutinizing

Investors, beware. Although you may like the flow of cash you are receiving as companies increase their dividends and buy back their shares, the buybacks in particular may not be a healthy signal for the economy or for investors. That is the conclusion Peter L. Bernstein, who runs an eponymous economic consulting firm in New York, drew from an analysis of the buyback phenomenon. In his July Economics and Portfolio Strategy commentary, he examined the trends of buyback activity between January 2001 and January 2007, and found that companies were less interested in buying their stocks when the stock prices were low and more interested when their prices were high. This buying occurred despite “breathtaking increases in profitability” and strong cash flow that could have paid for corporate investment. There are two possible explanations for this dramatic increase in buyback activity — combined with a rapid increase in dividend payments — according to Mr. Bernstein. First, management teams see too few future investment opportunities for their companies to justify spending their cash flow on anything more productive than buybacks. Second, perhaps the buybacks are about pushing up the stock price in the short run, “and the devil takes the hindmost of the long run,” Mr. Bernstein said. Neither explanation is good for investors in the long run.