Be Ready for Stock Buybacks

Besides dividends, companies are likely to use stock buybacks to return more cash to shareholders than they have in years, according to recent research.

Chip Dickson, portfolio strategist at Lehman Brothers, estimates that companies of the Standard and Poor's 500 Index will have roughly $450 billion in cash to spare after restructuring charges and paying out dividends this year. He has developed a simple system to identify those that are likely to use their excess funds to buy back stock.

Smart investors can position themselves for the wave of cash by buying into companies that have a record of at least one year of earnings growth, plus expectations of at least one more year's earnings growth, and a recent buyback of at least 2% of outstanding stock.

For the last criterion, Dickson seeks companies with a history of repurchasing more than they issue through stock offerings and employee compensation.

In addition to paying the cash bonus, the stocks of companies that buy back their shares typically perform better than the broader market.

Dickson created a hypothetical portfolio comprising equal investments in stocks that meet his earnings and buyback criteria. Every quarter, Dickson adjusted the portfolio to keep his investment in each stock equal, and to make sure that he included only stocks that continued to live up to his buyback criteria.

Using historical data from 1984 through 2005, the portfolio returned an annual average 19.9%, compared with 12.8% for the Standard and Poor's 500 Index.

Dickson's hypothetical portfolio was only slightly more risky than the index, as measured by the average annual fluctuation in returns.

Stock repurchases are attractive to corporate financial executives because they don't commit a company to a dividend policy that may have to be curtailed in the future if fortunes change.

Dickson's research identifies companies that have a history of buybacks in a range of industries, including consumer products, financial services, health care and information technology.

Many household names appear on Dickson's list, among them Procter & Gamble Co. (PG) , Goldman Sachs Group (GS) , RadioShack Corp. (RSH) and J.C. Penny Co. (JCP).

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