Tricks Of The Trade

Balancing Act

To an unknowing observer, October 27, 1997, seemed like any other day on Wall Street. But after a steep drop in foreign markets, the U.S. stock market tumbled, dropping several hundred points before circuit breakers shut the action down. The next day, traders and investors awaited the opening with the trepidation of acrobats on a high wire in a hurricane. Stocks opened down but bounced back after IBM announced a stock buyback, the announcement acting like a safety net for the plummeting market. In all, 120 companies announced plans to buy back shares of their stocks, and some analysts viewed these announcements as part of the sentiment that stopped the market's free fall. Stock buybacks are seen by many investors as a sign that a company's stock is undervalued. Often, the share price rises after the announcement of a buyback; after all, if shares are good enough for a company to buy back, they should be a pretty good buy anyway, right?

Not so fast. First, while many companies announce share buybacks, businesses are under no obligation to make good on their claims. Some companies do repurchase shares, buying them only to reissue to employees in the form of stock options. Still others borrow heavily to buy shares, thus replacing equity with debt, leaving investors with a more leveraged company, a weaker balance sheet and more potential difficulty in an economic downturn.

Share buybacks are enticing, but before you invest, make sure the company's earnings are still growing, not faltering. The repurchase of shares could limit a company's ability to invest in research and development or buy another company. So look before you leap.

The properties of stocks may not seem so magical now, but we hope you'll see this is one act that may have something for everyone. Come one, come all.

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This article was originally published in the March 1998 print edition of Entrepreneur with the headline: Tricks Of The Trade.

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