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Stocks for cannibals

There's nothing like cashing your first dividend cheque to develop your taste for raw capitalism. That's when it hits you that simply by buying a share in a firm you can enjoy a perpetual stream of dividend income with no further sweat or toil.

But dividends are only the most obvious way that companies reward shareholders. You can also reap big benefits when companies decide to buy back their own stock.

A buyback provides you with an easy way out the door if you're looking to sell your stock. On the other hand, if you want to hold on tight, a buyback increases the percentage of the company you own, because fewer shares are now on the market. It may sound odd to applaud a shrinking number of shares, but the fewer the shares, the better your bottom line. Profits now get divvied up among a smaller number of hands, so earnings per share tend to go up. That, in turn, leads to a higher share price.

As a fan of value stocks, I appreciate companies with a history of buying back their own shares. But you have to watch out for a few tricks. Some companies announce, with great fanfare, that they'll buy back stock, but never get around to doing it. Even worse, they might buy back stock that was created when management cashed in overly generous option packages. In this case, cash is being transferred to greedy managers and not to investors.

To avoid being taken in by these shenanigans, look for companies in which the total share count has declined over many years. I like to focus on stocks that have not only repurchased shares during the past five years, but also pay dividends. I stick to firms with a history of paying at least 3% annually in combined dividend yield and buybacks. I narrow the list by seeking stocks that are both cheap and relatively safe meaning a price-to-book-value ratio (P/B) of 1.5 or less, and more shareholders' equity than debt.

These criteria are demanding and only a few stocks passed all my tests when I crunched the numbers on April 3. Let's look at the top two candidates in the U.S. and two more in Canada.

Westwood One (NYSE:WON) provides programming and news to radio and television stations in the U.S. It pays a healthy dividend yield of 3.6% and it has repurchased an average of 4.3% of its shares annually over the last five years. The company trades at a price-to-earnings ratio (P/E) of only 11.8 and a price-to-free-cash-flow ratio of a mere 10.8. Its next few quarters may prove difficult, but a low share price will allow Westwood to repurchase even more shares, provided its cash flow remains robust.

Blair (AMEX:BL, $41.88) sells apparel and home products to Americans through catalogues and over the Internet. While profitable in each of the past 10 years, Blair has recently undergone a transformation. Under pressure from shareholders, it sold its receivables and used the cash to buy back over half its stock. The company also doubled its dividend yield to 2.9%. Despite the massive buyback, Blair still trades at only 1.3 times its book value and at a price-to-sales ratio of only 0.36. While I don't expect another 50% buyback, shareholders should see more money sent their way.

Samuel Manu-Tech (TSX:SMT) manufactures and distributes metal, plastic, and packaging products throughout North America. The Toronto company pays a dividend yield of 2.9% and has bought back shares at an average annual rate of 1.3% over the last five years. It's trading near its 52-week high, but still changes hands for only 1.3 times book value and less than eight times earnings. The company has cut its debt to 0.11 times equity, which puts it in good position to weather downturns.

Danier Leather (TSX:DL.SV) is a Toronto company that sells leather goods through its Canadian stores. It has cut its subordinate-voting shares by 22% over the last five years and it pays a generous dividend yield of 2.8%. Legal wrangling with a group of former investors has been a major factor in driving down its share price, but the company finally appears to be on the winning side. Although this winter's warm weather hurt sales, Danier remains profitable and trades at only 1.1 times book value. But take care: Danier is the smallest of the four stocks and its shares trade infrequently.

As always, before buying any stock, do your own research and make sure it is a good fit for your diversified portfolio.

From the May 2006 issue.

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