Are Buybacks with Cheap Credit Good For Invesotrs?

Interesting report on Bloomberg today regarding companies using cheap credit to buyback stock. Our Net Payout Yield Portfolio favors companies with a buyback much more then the general market, but we're not sold on companies borrowing to buyback stock. In our opinion all buybacks should be made from operating cash flow. True, stocks are at historically low PE multiples and interest rates are at record lows providing a compelling opportunity for some financial engineering, but companies should never worsen their balance sheet unless they are investing in a new service or capital equipment that will provide higher earnings in the future. Buying back stock only increases earnings per share but not the total earnings. The company is not better off and in fact is worse off with the higher debt loads.

Its almost as if companies have learned nothing from governments. Once this cash is spent on buybacks, they'll then have to figure out how to pay back the borrowings and maybe at higher rates next time. Not to mention the corporate world doesn't reward one time ingenious buybacks. Our advice, resist the temptation and just buyback what you can out of your existing cash flow.

• American companies announced $55.9 billion in repurchases since June, data compiled by Birinyi Associates Inc. show. That adds to $93.5 billion in the second quarter and $108.3 billion during the first three months of the year, compared with $125 billion in all of 2009. Corporations are using debt to pay for buybacks after the average yield on U.S. investment grade bonds fell to an all-time low of 3.70 percent last month, data from London-based Barclays Plc show.
• Companies from Microsoft Corp. to PepsiCo Inc. and Hewlett- Packard Co. are taking advantage of low-cost financing, purchasing their stock to boost per-share earnings at a time when the Standard & Poor’s 500 Index trades at a 26 percent discount to its average valuation since 1954. At the same time, choosing buybacks may show executives are too concerned about the economy to invest in new projects or make acquisitions. 
• U.S. companies have announced $258 billion in buybacks so far this year, compared with $52 billion in the first three quarters of 2009, according to data compiled by Birinyi. The almost fivefold increase is the largest for any January-to- September period since at least 2000, when the Westport, Connecticut-based research firm started tracking the data. 
• Per-share free cash flow in the S&P 500, or earnings minus capital expenses, rose to $102.01 this quarter, the highest level since at least 2000, according to Bloomberg data. Excluding banks, brokerages and insurance companies, S&P 500 companies generated $682.2 billion in cash and near-cash items last quarter, the data show. (why borrow money instead of just using this cash flow?)
• “Corporations are finally feeling a little bit more comfortable and realizing that their own shares are cheap and financing is very cheap, so why not issue some debt and buy back stock?” said David Kelly, who helps oversee about $445 billion as chief market strategist for JPMorgan Funds in New York. “That’s a great way of distributing cash to shareholders and boosting stock prices.”(taking on more debt doesn't increase shareholder value)