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number cruncher

Best Buy: While the electronics retailer has rewarded shareholders by buying back its own shares, it may be too risky for many investors.Shannon Stapleton/Reuters

What are we looking for?

Stocks that might benefit from dividends' unsung sibling.

While investors are obsessed these days with dividend-paying stocks, they are paying far less attention to companies that are buying back their own shares – even though both dividends and buybacks are ways for management to funnel cash back to shareholders.

Done properly – that is, when shares are trading at bargain-basement prices – buybacks can be a wise use of a firm's money.

By shrinking the number of shares outstanding, a company ensures future profits are shared among a smaller group of shareholders.

How we did it

We searched for stocks in the S&P 500 and the S&P/TSX composite that have reduced their number of shares outstanding by at least 15 per cent over the past three years.

In an effort to ensure these firms still represent value, we also required each stock to be trading at a price to earnings (P/E) of 14 or less, and an enterprise value to earnings before interest, taxes, depreciation and amortization (EV/EBITDA) of eight or less.

What we found

No Canadian stocks made the cut. It appears that management in this country is relying more on dividends than buybacks to reward shareholders.

The U.S. stocks that made the list are an intriguing lot and not always in a good way. Best Buy Co., for instance, is a troubled electronics retailer that may be too risky for many investors.

Still, many of the firms on the list – like Western Union and DirecTV – pop up frequently in discussions of interesting value stocks.

As always you should do your own research before buying any of these names. The danger with share buybacks is that management may decide to purchase shares when they're overvalued. In that case, buybacks can destroy value.

However, a firm that is shrinking its number of shares outstanding is often motivated by a belief that its equity is undervalued. In those cases, a wave of buybacks can signal a rising share price ahead.

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