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David Fried, editor of the Buyback Letter, explains how he builds portfolios based solely on companies undergoing buyback programs, and highlights some favorite buyback bets for investors.

Steve Halpern: We're here today with David Fried, editor of the Buyback Letter. How are you doing, David?

David Fried: I'm doing well, thank you. How are you doing?

Steve Halpern: Very good. For those who aren't familiar with buybacks, could you explain a little about your interest in this area, how you got involved, and what impact that buyback has on a stock.

David Fried: Sure. Well, there's been a lot of research done on buybacks and companies typically will buy back stock when it's undervalued.

Now, it may be undervalued given an absolute outlook, or it may be undervalued given the future of what's going on with the company, and, of course, the insiders at the company have a bird's eye view for that.

We really consider the ultimate to be insider buying, because the whole Board of Directors and management, pretty much, has to be on board to agree and spend company funds to buy back shares.

Steve Halpern: So this is insider buying that's the legal version of it.

David Fried: Yeah, it's been referred to as legal insider buying, absolutely.

Steve Halpern: Okay, importantly, you could buy buyback stocks into several categories. First, you observe that there are companies that announce buybacks, but don't actually follow through with that. How big a problem is that?

David Fried: Well, it's not a problem for us, because we track the actual share count, so if a company doesn't buy back, it just doesn't wind up on our screen.

Also, in times of market stress, sometimes the company will announce a buyback, and the price of the stock goes up with the market, if the market recovers quickly, and those shares don't get bought back, so it's not necessarily a bad thing. It really depends on the circumstances.

Steve Halpern: So, from your standpoint, it's not as important what the company says it's going to do. You actually wait and to see the follow-through to make sure they actually do that.

David Fried: Yes, Steve, that's exactly right. That's what we key our purchases and our recommendations on.

Steve Halpern: Now you also note that there are companies that only buy back their stock when they consider their stocks to be at bargain prices. I assume you're always interested in finding those types of companies.

David Fried: Yeah, we always are. We have our metrics, at the BuybackLetter.com, that we look for a combination of valuation and how much stock has been taken off the market.

And when we talk about buybacks, we don't mean simply buying back shares; we mean enough share repurchase to offset any delusion from options, so we're actually looking for companies that have a negative year-over-year share count.

Steve Halpern: Now you've also noted that there are select companies that are committed to long-term buyback programs. How did these play a role in your strategy?

David Fried: Well, they come in and out, because the strategy is based on the near- and medium-term valuations, so those companies, like all companies, can be overvalued at times and undervalued, but they are really, really good to look for, to stash in your portfolio when they're undervalued.

If people subscribe to the newsletter, we give them a free report on companies that are really good long-term purchasers of their own stock.

And as they purchase the stock, the earnings per share goes up, and up, and up. If you have a 10% grower, that is taking off 5% of their stock every year from the market.

Now all of a sudden you've got a company that's growing their earnings at 16%-18%, and it really shows up in the P/E and the long-term value for shareholders.

Steve Halpern: In fact, the Hulbert Financial Digest, which monitors the performance of newsletter portfolios, has reported that your model portfolio shows an average annualized return of 9.4% going back over 15 years, which has more than doubled the 4.4% return to the S&P 500. Could you tell us a little about these portfolios and how you develop them?

David Fried: Sure. Before I was a newsletter writer, I was an investor and a consumer of newsletters, so I kind of knew what I didn't like, and I wanted to make things very clear for the subscriber, so what we have is five separate portfolios, each appealing to a different niche in the market.

One of the portfolios is what I call the buyback dogs. Those are five stocks from the Dow Jones Industrial Index and we take the best buyback stocks from that index.

Then we have a dividend income index for people who want dividends. That's a 10-stock index, and those combine high-yield and the buyback characteristics that we look for.

We then have a basic 20-stock diversified portfolio, which pulls from, which doesn't have rules on where the stock has to be from, and then we have a sector portfolio for high-tech and a sector portfolio for health and biotech, so we offer five portfolios.

We also offer a premium portfolio, which is for people who really trade a lot; it's five ideas a month, and we add to that, 25, approximately 25 ideas that were near selection for those five, but didn't quite make it, but are certainly worth looking into, for people who are active.

You mentioned the Hulbert Financial Digest—we've also been on the Honor Roll for three straight years now.

Hulbert ranks us in “A” for clarity and that's really the thing that I think I'm most proud of is that subscribers really will not have a problem following what we do.

It's clear, and it's laid out, and it's understandable, and they don't have to go through any brain damage.

Steve Halpern: Okay, I don't want to end the interview without asking you if you'd be kind enough to share a couple of names, for listeners, of the companies that are buying back shares that you think might be attractive for investors to be looking at today?

David Fried: Sure. I mean, one of the companies, to go back to your question before, if you want to talk about a company that buys back stock as a part of the culture and a part of the corporate plan is AutoZone (AZO).

If there is one buyback stock that I would want an investor to own—if they said I could only buy one buyback stock, what would it be? It would be AutoZone.

They just have a great record of shrinking their share account and therefore really boosting shareholder return. I invite anybody to take a look at that and take a look at their long-term, short.

Another one for dividend income would be Lorillard (LO). They have done a great job of both increasing dividends, and buying back stock, and building shareholder value, and both of those are off their highs a little bit right now, but you can still see that their long-term charts and fundamentals are intact.

So I would recommend those two without getting into too much detail, and they've been pretty good long-term performers, and if one's a patient investor, they should do pretty well.

Steve Halpern: Well, we appreciate you taking the time today. Thanks for joining us.

David Fried: Steve, thanks so much for having me.

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Tickers Mentioned: AZO, LO

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