It’s a bullish sign when a company buys back its own stock!

Dear fellow investor.

Shareholders and investors in two blue-chip companies received some good news on Monday, July 9, 2007, which has potentially bullish long-term consequences.

First, Johnson & Johnson announced the repurchase of up to $10 billion of its common stock.
ConocoPhillips then announced the repurchase of a $15 billion share buyback program, representing a $13 billion increase over the $2 billion that remained in a previous buyback program.

But why is a buyback program a positive sign for investors? Why would a buyback have such upside potential? One explanation is in terms of simple supply and demand: buybacks reduce a company’s supply of outstanding shares, which should increase the price of the shares that remain.

Another explanation is that companies that buy back their shares are so confident in their future prospects that they are willing to commit corporate resources to buy them. This is worth paying attention to, as a company’s executives and board of directors have access to inside information that the rest of us don’t.

As such, buyback programs are analogous to corporate employees buying shares of their companies for their own accounts. Both indicate confidence in the company’s future prospects, which is again a bullish sign.

In one word:

When a company reduces the number of shares outstanding by declaring a share buyback program, each share becomes more valuable and represents a larger percentage of the company’s share capital.

So when building your portfolio, you can look for strong, solid companies that engage in these kinds of shareholder-friendly practices and stick with them as long as the fundamentals remain strong.

One of the best examples is the Washington Post, which at one point was only $5 to $10 a share. It has already traded up to $650. That’s what I call long-term value!

But be careful! Although buybacks can be a great source of long-term profit for investors, they are actually harmful if a company pays more than its shares are worth. In an overvalued market, it would be foolish for management to buy shares, even themselves.

Instead, the company must invest the money in assets that can be easily converted back to cash. This way, when the market has swung the other way and is trading below its true value, the company’s shares can be bought back at a discount, ensuring that current shareholders receive the maximum benefit. Remember, even the best investment in the world is not a good investment if you pay too much for it.

Yours in Successful Trading

Ricky Schmidt