You probably won't find me writing much about the stock market and investing.  While I have money in play, I'm certainly not an expert so don't view any of this advice as a recommendation one way or another.  This articles is really a business management advice article of which I do have plenty of experience.  Always Invest at your own risk!  

What prompted me to write about stock buybacks was a company I was following, eHealth (NASDAQ: EHTH), announced a share buyback.  The company, which has a market capitalization of around $250 Million, has more than half that amount sitting on it's balance sheet in cash and this is a profitable company.  To summarize, tons of cash in the bank and continuing profits.  What's the issue then?  Analysts had said that the company would be adversely affected by passage of the Health Care Reform Bill.  Also, the company has started to show slowing revenue growth and problems with subscriber churn.  To shore up revenues, the company used some of its cash to make the acquisition of PlanPrescriber, Inc.  

In spite of what analysts were saying, I still liked this company because of its strong cash position and it's ability to continue making profits despite a slowdown in revenues.  With that much cash, the company could continue making strategic acquisitions like they did with PlanPrescriber.  In addition, the company could look into new revenue generating opportunities by using the cash to grow organically.  

However, that all changed when on the day of their 2nd Quarter Earnings release, they announced a share buyback.  What this signals to the market is that the best use of their cash isn't buying other companies, increasing sales & marketing or venturing into new business areas to increase revenues.  It's buying their own stock!  Why would a company simply remove cash from their bank and vaporize it by buying their own stock?  The only strategy that I could think would make sense would be for them to then use the stock to buy other companies and not dilute shareholders, but that doesn't really make sense either since they could simply use cash to buy other companies.

On the surface, when a company announces a share buyback, it seems like they are showing confidence in their own company by buying the stock.  However, the opposite is actually true.  It means they have no confidence in themselves to properly spend the cash to grow their business!  They are admitting that the only way they know to return value to shareholders is to buy back their stock.  This is a clear selling signal.  I don't have research to back up my line of thinking, but I'm sure that after some poking around you'll see that stocks that return the most going forward aren't from companies buying their own stock.  Stocks in companies increase when they use their cash to grow their business.  If they want to return money to shareholders, then pay a dividend!

Well known Venture Capitalist, Fred Wilson makes a much better case then me on why stock buybacks are shortsighted.  

The best signal eHealth could have made would have been if it's executives used their own money to buy the stock instead of using the company's cash to buy the stock.  Effective cash management is a skill only the best of executives possess.  Rarely are stock buybacks an effective use of cash by companies.  It's true that earnings per share will increase when there are less shares outstanding, but buying back common stock doesn't increase revenues, increase cash from income or provide much of any other benefit other than adding window dressing.   The only way buying back stock makes sense is if it's preferred stock which can have interest payments.  Obviously a reduction in interest payments increases cash flow for a company.

You can come to your own conclusions about whether eHealth's management is making the best use of its cash or simply applying window dressing to make a declining business look better.