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3 cheap stock buyback plays

April 2, 2014: 10:00 AM ET
This discount carrier knows something about a deal. Southwest bought nearly 40 million of its own shares last year.

This discount carrier knows something about a deal. Southwest bought nearly 40 million of its own shares last year.

This article was published in the April issue of Money magazine.

Investors often cheer when businesses aggressively purchase their own stock, as is the case today. Not only do buybacks boost earnings per share by reducing the number of shares outstanding, but they're also a sign of confidence. If a CEO thinks his stock is worth buying, shouldn't you?

Often the answer is yes. Consider that the PowerShares Buyback Achievers ETF (PKW) has returned 19% annually over the past three years, beating the S&P 500 by more than five points a year.

Not all repurchases, though, are well timed. A Credit Suisse study found that companies tend to go on buyback sprees in frothy times, like 2007, while cutting back at market lows, like 2009. Businesses trading at exorbitant valuations probably shouldn't be deploying cash to boost already pricey shares since there are better (and cheaper) uses for those resources.

With that in mind, I screened for buybacks of solid firms that trade at low price/earnings ratios relative to their peers. I also focused on dividend payers with low debt, signs of sound management. Here are three that made the cut:

Southwest Airlines (LUV)

This discount carrier knows a little something about a deal. Last year, Southwest bought nearly 40 million shares and lowered its share count by about 5%, notes Todd Smurl, manager of the Patriot Fund. But Smurl, whose fund owns the stock, notes that there's also a growth story here.

The company's recent purchase of AirTran now gives it international exposure: Southwest will soon start flights to the Caribbean. The airline is also set to gain slots in Washington, D.C.'s Reagan airport, after recently entering New York's LaGuardia Airport, Boston, and Minneapolis--St. Paul.

3M (MMM)

What's so impressive isn't that this conglomerate gulped $5.2 billion of its shares last year. 3M did so while still boosting R&D, says Brian Clancy, co-manager of Davidson Multi-Cap Equity, which owns the stock.

Related: Invest in innovation - 5 stock picks

Clancy says 3M doesn't get enough credit for its lucrative health care, industrial, and renewable-energy businesses. This company is much more than Post-it notes and Scotch tape, he says.

Oracle (ORCL)

CEO Larry Ellison transformed this database giant by buying up a myriad of other software businesses. Yet Oracle has also been a consistent purchaser of its own stock.

And unlike many tech companies that announce buybacks just to offset new shares issued via mergers, employee option grants, and executive bonus programs, Oracle has actually been reducing its share count -- by 5% in the first six months of this fiscal year. This, at a time when the stock trades at a discount to the S&P 500 and the tech sector. You don't need a computer program to tell you that's a deal.

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