SM: 3 Retailers Betting Big on Shares

A trio of retailers has lately spent massive sums on a single investment: their own stock.

Stock repurchases are one of two ways companies return the cash they earn to investors. Dividends are the other. The long historical record for stocks suggests dividends are an important part of total returns. The record on repurchases, which have become common only over the past 30 years (especially the past 10), is less clear.

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The problem: While most companies spend steady amounts on their dividends (apart from periodic increases) they spend sporadically on their shares, buying plenty of stock when profits are plump and little when profits are slim. That leaves companies prone to paying too much.

For example, repurchases for S&P 500 companies hit a record in the third quarter of 2007, just before the index hit an all-time high. They fell to a trickle in the middle of 2009, near the index's financial-crisis low. Now repurchases have bounced back--along with stock prices.

Not surprisingly, returns for companies that buy back stock aren't particularly impressive in studies. But there's an important exception: Those whose shares are cheap relative to fundamental measures of value, like earnings and the book value of assets, tend to outperform following repurchases. This is understandable: what matters as much as the amount companies spend on stock is whether they're getting a good deal.

That makes huge repurchases fairly aggressive bets for the companies below. Repurchases in general can increase earnings per share by reducing the number of outstanding shares. That can attract buyers to these stocks. If it works, the companies will have put shareholder cash to good use, and if it doesn't, well, these companies will have increased their exposure to stock price declines.

Gap

Price/earnings: 14

Gap (GPS), which operates its namesake clothing chain as well as Banana Republic and Old Navy, is in a long funk. Its "same-store" sales, which exclude newly opened or closed stores to give a sense of whether customer demand is rising or falling, were sliding long before the recent recessions and have continued declining through much of the recovery. In January, same-store sales fell 4% from a year earlier.

Remarkably, the stock has jumped 15% this year. Wall Street was looking for a bigger sales decline. Also, management said fourth-quarter earnings per share for its fiscal quarter ended Jan. 29 would be higher than analysts expected. Gap spent more than $2 billion on its shares during the previous three quarters. That's nearly 20% of its current stock market value.

Best Buy

Price/earnings: 8

Electronics chain Best Buy (BBY) missed Wall Street's earnings forecasts during its second and third quarters. Analysts blamed weak pricing amid competition from online merchants like Amazon.com (AMZN) . The company reaffirmed earnings guidance for its fourth quarter, which ends Feb. 26, even though December same-store sales slipped 1.2%.

Share repurchases are helping with earnings per share. During its first three quarters Best Buy spent $1.2 billion on its stock. That's 13% of its current market value.

Kohl's

Price/earnings: 12

Department store Kohl's (KSS) has been a fast grower over the past decade, increasing its earnings per share at an average of 14% a year, compounded. Lately its sales are growing merely in line with other stores. For the company's fiscal year ended Jan. 29, Wall Street projects a 2% sales increase. (Same-store sales have increased 0.5% year-to-date following a slight decline in December.) Yet for the same period analysts are looking for an 18% jump in earnings per share.

The company spent $1.9 billion on stock during its first three quarters. That's about 15% of its current stock market value. Making the bet even more aggressive, Kohl's issued $650 million in notes in October, paying a 4% coupon. That means it is in effect swapping stock for debt in a leveraged bet shares will rise. They're higher year-to-date but down 3% in price from a year ago.