Sears’ bankruptcy came as no surprise to me (see my article to this end). Due to reckless stock buybacks, Sears’ management depleted cash, working capital, and equity to the point where Sears did not have adequate capital to reinvent itself to compete in the hyper-competitive retail sales marketplace. When analyzing a publicly traded company’s financial statement, I do so heeding the wisdom of Benjamin Graham and David L. Dodd as expressed in their classic book Security Analysis. A key concept, to be found in this book, pertains to “margin of safety:”
…in the selection of primary or leading common stocks for conventional investment, such a margin between value and price has not typically been present. In these instances the margin of safety is contributed to by such qualitative factors as the firm’s dominant position in its industry and product markets and expected growth in earnings. Thus in valuing common stocks, the analyst will need to consider carefully qualitative factors as well as quantitative. Other factors that contribute to a margin of safety include assets carried in land and property accounts at amounts substantially below their current market value (e.g., timberland or mineral reserves) and cash flows that provide a degree of financial flexibility and therefore allow a business to withstand adversity, to add to or change product lines, and to take other action that will improve the competitive position of the company. (pg. 129, Fifth Edition)
When taken too far, stock buybacks can deplete a company’s balance sheet to the point where there is no margin of safety to adapt to adverse changes in the economy, to changes in the competitive landscape, and to changes in consumer tastes. Having analyzed J.C….