Saturday, January 3, 2009

Be Wary Of Buyback Announcements

Shares in TAT Technologies (TATTF) rose last week as the company announced a plan to buy back around 10% of the company's shares. Shares usually do rise in response to such announcements, as they imply that management believes a company's shares to be undervalued. Since management knows the business better than anyone, the market responds positively. Unfortunately, investors cannot rely on announcements such as this in order to determine whether a company is undervalued.

First of all, because such announcements usually result in a stock price boost, unscrupulous managements can use this method to simply boost the stock price to a level higher than it otherwise would be. Furthermore, managements are subject to the same psychological forces that govern the market, and as such they can often be woefully wrong about whether a stock is undervalued. Often, there are also incentives for managements to buy back stock other than a belief that the stock is undervalued. For a discussion on such incentives, see this article discussing the terrible buyback decisions of several large companies.

To determine if a company is undervalued, the investor's best approach is still to determine an estimate of the company's intrinsic value (which we discussed here for TATTF), rather than relying on fruitless attempts to gauge management's opinion of a stock.

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