By Philip van Doorn, MarketWatch
MarketWatch photo illustration/Everett Collection
Technology stocks have led the market this year, helped by share buybacks, but there are red flags for some of the companies.
If a technology company spends more on buybacks than it does on research and development, it may mean the company is sitting on a mountain of cash and that its board of directors thinks the shares are priced attractively. Apple /zigman2/quotes/202934861/composite AAPL +0.25% , with its huge cash hoard, is an example of this type of thinking — and its stock returned 51% for the 12 months through Nov. 2. Buybacks lower the share count, automatically increasing earnings per share, a main metric of investing.
But what of other companies? Maybe a high level of spending on buybacks reflects a lack of new ideas or a loss of aggressiveness needed to compete as other companies keep pushing to innovate and take market share.
Intel’s sluggishness vs. AMD’s nimbleness
MarketWatch’s Beth Kindig argues that semiconductor stocks are overvalued. She recently made an insightful point about Intel /zigman2/quotes/203649727/composite INTC +1.90% : The chipmaker spent $4.5 billion on share repurchases during the third quarter versus $3.2 billion on R&D. That is something you might question, considering how fierce competition can be among semiconductor manufacturers as the industry continues to innovate and take advantage of the opportunities offered by electric vehicles, the internet of things (IoT) and 5G.
In fairness, if we look back over the past 12 reported months, Intel’s $13.4 billion in R&D spending exceeded its $12.4 billion in share buybacks. But what did that $12.4 billion do for investors?
Intel’s third-quarter average diluted share count, which is used to calculate earnings per share, declined to 4.433 billion from 4.648 billion a year earlier. Third-quarter net income declined 6% to $5.990 billion from $6.398 billion a year earlier. But earnings per share declined only 2% to $1.35 from $1.38.
If Intel’s third-quarter share count had been the same as a year earlier, its EPS would have been $1.29. So the $12.4 billion in buybacks got Intel’s shareholders an extra 6 cents a share of EPS.
Intel’s third-quarter revenue was up slightly from a year earlier, but its gross profit margin narrowed to 58.6% from 64.2%, according to FactSet. (A company’s gross margin is its sales, less the cost of goods sold, divided by sales.)
Intel’s stock was up 25% for the 12 months through Nov. 29, with dividends reinvested. That’s great, but it trails the S&P 500 /zigman2/quotes/210599714/realtime SPX +1.05% information-technology sector’s return of 33%. Over the same period, Intel’s smaller rival Advanced Micro Devices /zigman2/quotes/208144392/composite AMD -2.40% saw its stock return 83%, with no money spent on share buybacks. AMD’s third-quarter sales were up 9% from a year earlier, while its net income was up 18%. AMD’s third-quarter gross margin expanded to 43.1% from 40%.
None of this is to say Intel’s numbers aren’t impressive — the company is quite a money maker and has dominated in the field of PC processors for decades. But MarketWatch’s Kindig was on to something when she wrote that Intel was “competing to meet consensus earnings estimates rather than to increase market share.”
In an opposing view, Deepon Nag, senior technology hardware analyst at ClearBridge Investments (a subsidiary of Legg Mason) in New York, argued that Intel’s buybacks are “a message to investors that it will no longer pursue wasteful M&A with its hard-earned profits.”
He doesn’t credit AMD’s decision to spend on R&D rather than buybacks for its success, but, rather, the company’s “canny allocation of the dollars it has spent as well as transformative innovations — combined with Intel’s stumbles — that have allowed it to get the business back to growth.”
As you can see on the third table below, Broadcom’s /zigman2/quotes/200646538/composite AVGO -0.64% spending on buybacks for the past 12 reported months totaled $7.35 billion, while its R&D spending was $4.47 billion. This is a red flag that warrants a closer look. The buybacks can be lumpy — $3.51 billion in buybacks took place during the company’s fiscal first quarter ended Feb. 3.
Charles Lemonides, founder and chief investment officer at ValueWorks LLC in New York, said in an interview that “Broadcom has been buying back shares at prices that cannot be sustained long-term.” He has a short position on the stock.
Broadcom’s shares returned 39% for the 12 months through Nov. 29, and if you look at the chart, you can see a strong move up when the company accelerated buybacks during the quarter ended Feb. 3. Here’s the two-year chart for the stock, through Nov. 29:
“This stock had a couple of moments when it was about to fall apart, and then they levered up and bought back more shares,” Lemonides said.
The company had $34.03 billion in long-term debt (excluding $3.54 billion categorized as a short-term portion of the long-term debt) as of Aug. 4 (the end of its fiscal third quarter), up from $17.49 billion a year earlier.