The Six Things I Look for in a Company Before Buying Its Stock

February 12th, 2014
in contributors

by Mitchell Clark, Profit Confidential

As evidence of the fervor that corporations have to try to keep shareholders happy, 3M Company (MMM) just announced that its board of directors authorized another major share repurchase program.

The company bought back $5.2 billion worth of its own shares in 2013 and can now repurchase up to $12.0 billion.

Stock buybacks are an old-school business strategy. Excess cash that management feels isn't worth investing in new businesses, plant, equipment, and employees is simply allocated back to shareholders.

Follow up:

And whatever the endgame is for company management-to boost a falling share price, pay for dividends, meet earnings guidance or simply because it's the easiest thing to do-share repurchases work for investors.

The stock market is a secondary market where share prices reflect relative values until a company becomes non-public (i.e. is taken private).

Some view share buyback programs as a tool a public company can use to prop up its earnings results, but in the large-cap space, this isn't the case. The fact of the matter is that big business generates a lot of cash and cash management has been and will continue to be one of the main operations (usually part of the executive branch) of a company.

Earnings results might be managed on a quarterly basis, but corporations typically take a longer view regarding interest rates and debt requirements. When rates are extremely low, as they are right now, debt financing makes a lot of sense. Corporations can and do "bulk up" on capital when market conditions warrant. (See "Pullback in Stock Prices Makes These Dividend Payers Attractive Again.")

Regardless of the motive, the marketplace likes share buyback programs, and it is one more tool that a company can use to keep its shares attractive to buyers.

I like a stock that offers a "package" of investor incentives; that includes growing revenues and earnings for sure, rising dividends, share repurchases, a strong balance sheet, and transparent financial reporting from management.

In a lot of cases, you aren't going to see non-dividend-paying companies repurchasing shares. Presumably, a company that's more growth-oriented doesn't want to spend precious capital on dividends and share repurchases. That capital is required for business expansion.

It makes a lot of sense, however, for blue chips to do so. Mature businesses like 3M Company can really only grow at an above-average rate through acquisition.

But for investors, we've seen the combination of modest financial growth coupled with increased dividends and share repurchases as powerful for a catalyst for capital gains among large-cap companies that you don't expect to be big movers.

Blue chips have a tendency to experience longer periods of non-performance (or relative outperformance if stocks are falling), then they explode with capital gains. This is exactly what happened in 2013, and 3M Company was the perfect example.

Which is why increasing dividends is such a powerful attribute for investors. Rising dividends combined with share repurchases make for great stocks for investors to consider.

This article The Six Things I Look for in a Company Before Buying Its Stock was originally posted at Profit Confidential.

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