Deep Dive

Opinion: Companies are wasting money from layoffs on share buybacks

By Philip van Doorn

Published: Oct 25, 2015 11:17 a.m. ET

Dow Chemical, 3M and other companies might want to concentrate more on boosting sales

What do you make of a company that announces restructuring moves that include possible job cuts while it buys back shares?

For starters, if a company whose stock you own continues to boost (or mitigate the decline of) earnings per share (EPS) by buying back shares, while not increasing sales, chances are the buybacks aren’t helping. The stock has probably been declining in value, and EPS may not be growing. Maybe the buybacks aren’t reducing the diluted share count by much because so many new shares are being handed to executives.

That is why it’s a good idea to pay attention to companies’ quarterly earnings announcements, despite unctuous executives’ insistence on using so much boiler-plate language when communicating with their companies’ owners.

Not all buybacks are bad, and not all restructuring plans are bad. But a combination of the two warrants extra scrutiny.

Here’s a mixed bag of big companies’ restructuring announcements Wednesday and Thursday:

• Biogen Inc. said it would cut 11% of its workforce, even though the company beat the consensus third-quarter earnings estimate, increased sales by 11% and raised full-year earnings guidance. Biogen plans to cut expenses by $250 million a year and reinvest the money in various initiatives. Also on Wednesday, Biogen said that as of Sept. 30, it had completed $3 billion of its $5 billion share-buyback program, and had bought back another $900 million worth of shares since Sept. 30. The average share count for the third quarter was down 1.8% from a year earlier.

• 3M Co. will slash 1,500 positions worldwide and save an estimated $130 million pre-tax next year. Third-quarter earnings per share were up 3.5% from a year earlier, but sales were down 5.2% because foreign-currency translations reduced sales by 7.4%. The company bought back $1.5 billion worth of shares in the quarter, and its average share count declined 4.1% from a year earlier.

• Dow Chemical Co. said it would continue a long series of restructuring moves in its partnership investments in Kuwait and the U.S. Gulf Coast, and receive $1.5 billion from a reduction in its ownership of MEGlobal. The company boosted its dividend by 10% and accelerated its stock-buyback plan. Dow’s adjusted operating earnings were up 15% from a year earlier to 82 cents a share. But sales slumped 16% to $12 billion, “driven by pricing and currency.” The diluted share count inched up 5.6% from a year earlier, reflecting the conversion of preferred shares into common shares. Dow spun off Olin Corp. on Oct. 5. That deal reduced Dow’s share count by about 34 million, completing $6.5 billion of a $9.5 billion share-repurchase program.

• Caterpillar Inc.’s third-quarter earnings tumbled to $368 million, or 62 cents a share, from $1 billion, or $1.63, a year earlier, as sales dropped 19% to $11 billion. The company expects restructuring costs to total about $800 million for 2015. The company said Sept. 24 that it will slim its workforce by 4,000 to 5,000 salaried employees by the end of 2016, with cuts of up to 10,000 by the end of 2018. Severance costs will ultimately total about $2 billion. Caterpillar’s full-time headcount declined by 2,325 to 108,922 employees in the third quarter. The company bought back $1.5 billion in shares in those three months, leaving the share count down 4.5% from a year earlier.

• Perrigo Co. said it would cut its workforce by about 6%. The company didn’t provide a specific number of jobs, though Perrigo had 7,550 employees at the end of 2014. As part of its strategy to fight off a takeover bid by Mylan NV Perrigo said it would sell its vitamins business and buy back $2 billion worth of shares. The over-the-counter and generic-drug manufacturer said net sales soared 41%.

International Business Machines Corp. didn’t announce any layoffs for last quarter, but said it bought back $1.5 billion worth of shares. Meanwhile, its stock dropped 10% in those three months. Its own stock, alas, isn’t IBM’s best investment. Sales sank 13.9%, and operating earnings per share were down 9%, despite a 1.9% reduction in the share count.

The bottom line is that financial engineering could be a bad sign for an investor looking to make money from a long-term investment.

You should look beyond the headlines saying whether a company has “beaten” or “missed” quarterly estimates for earnings per share. They mean nothing. Any business or industry can have a bad quarter here and there, and it is quite common for an accounting or other change to greatly affect EPS.

Sales growth, or a lack thereof, can be a much better indicator of how a company is faring.

Meat and potatoes

Here are changes in third-quarter sales per share for the five companies listed above as well as IBM:

This shows a stark difference in what each restructuring story might really mean for investors. Yes, it’s sad to see so many people losing their jobs at Perrigo and Biogen, but at least the companies are increasing sales. And Biogen said it would use savings from the job cuts for new ventures.

If a company is generating better sales and earnings growth, stock buybacks can pay off nicely, since they boost EPS. Otherwise, this sort of “return of capital” can be a complete waste to shareholders, since the stock price may continue to slide.

IBM CEO Ginni Rometty said that the company had “strong growth [of 27%] in our strategic imperatives,” which include “cloud, analytics and engagement,” during the third quarter. That’s great, but what about the legacy business that’s dragging down revenue and profits?

If IBM were to make a radical transformation and unload more legacy units, what would it do with the cash? If it didn’t need the money to reinvest in its “strategic imperatives,” maybe a higher quarterly dividend or a special dividend would be much more friendly to shareholders. Yes, there might be tax disadvantages, but at least investors would have the money in their hands.

Here’s how the six socks have fared:

And here’s how analysts view them:

Philip van Doorn Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.

This is an interesting group of stocks because of all the moving parts, but even sell-side analysts, who tend to have a sunny view when assigning ratings, favor only Biogen and Dow Chemical.

The important thing for an investor is to take a keen interest in what’s really going on at a company. All companies try their best to paint a rosy picture in their quarterly reports. A deeper look may tell you something completely different.