On the Margin
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Why is Potbelly buying back shares?

This post is part of the On the Margin blog.

Share buybacks are all the rage. Just about every company is buying back shares, inflating their stock price by spreading earnings over fewer shares. It’s particularly common in the restaurant business.

So we shouldn’t be surprised at all at the announcement this afternoon that Potbelly Corporation has started a share buyback program.

The company said just after market close on Tuesday that its board had authorized the repurchase of up to $35 million worth of shares.

Share repurchases might make sense for a company like Potbelly, at least in one sense. The Chicago-based sandwich chain went public in 2013, more than doubled on its first day of trading, then started heading downward amid sales concerns. The company’s stock has been stuck in the low teens since July of last year. The price closed at just under $11 a share on Tuesday.

Companies buy back stock when they think that it’s undervalued. And several companies, including many restaurants, have successfully used buyback programs to keep their stock price afloat.

Given Potbelly’s low valuation, its buyback therefore makes more sense than the repurchase programs of those companies that are traded at elevated valuations.

And, indeed, Potbelly’s stock is trading up less than 1 percent in after-hours trading on Tuesday.Potbelly logo

But Potbelly is also a growth chain, with mostly company locations. Growth chains are supposed to be in need of cash to add new units, so they can spread their brand into more areas and generate higher total sales and earnings.

Instead, the chain is devoting that cash to share buybacks. Potbelly’s shift in strategy, therefore, could diminish its ability to expand in favor of a short-term boost in stock price.

“Theoretically, a company has to deploy capital where it can earn the highest returns,” said Nick Mazing, founder and portfolio manager of Ampera Capital, an investment manager that specializes in consumer and retail companies. “If Potbelly thinks that boosting (earnings per share) by shrinking share count is a better use of capital than opening new units, then the story that was sold to investors at the IPO has changed dramatically.”

Contact Jonathan Maze at [email protected].
Follow him on Twitter: @jonathanmaze

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