Goldman’s uphill buyback battle

July 26, 2011, 3:35 PM UTC

What if you announced a $10 billion stock buyback and drew a bunch of yawns in response?

That’s where Goldman Sachs (GS) finds itself a week after its disappointingly soft second quarter. The torpid reaction is only the latest sign that a weak economy, creaky markets and tightening  capital rules are squeezing the once mighty megabanks.

Ups and downs

Perhaps hoping to ease some of the sting of its rare earnings miss, Goldman said last Tuesday it would repurchase as many as 75 million shares in coming years. The plan isn’t novel: Goldman has spent $37 billion on buybacks since 2002 (see chart, right), mostly to mop up stock issued to pay its famously well compensated employees.

But the buyback plan is nothing if not big — and comes at a time when investors are wondering what sort of money they can reasonably expect to make backing the big banks, too big to fail or otherwise. Goldman’s return on equity in the first half of 2011 was at best half the firm’s long-term target. That performance goes a long way toward explaining the stock’s 15% decline this year, and no doubt puts the firm on its back foot in dealing with some owners.

“We remain focused on generating superior returns for our shareholders,” financial chief David Viniar said last Tuesday in announcing the plan on a conference call.

At current prices buying back all that stock would cost around $10 billion. Even for an outfit rolling in it the way Goldman is, that’s a good chunk of change.

What’s more, buybacks now look like a good deal for shareholders, which isn’t always the case. The firm has spent an average of $142 and change buying back shares since 2002 — well above the firm’s book value, a measure of net worth. But with the stock lately trading just above Goldman’s reported per-share book value of $131, repurchases may now make sense from a purely financial point of view – which is why Viniar said Goldman could potentially step up the pace.

Yet shareholders’ response has been decidedly lukewarm. While Goldman shares are up 6% over the past week, the bounce comes off a low not seen since April 2009, when the financial system was still smarting from the collapse of Lehman Brothers.

And while some boosters say a big blank check for buybacks could finally put a floor under the stock – “we believe downside risk is limited at this time,” writes Wells Fargo analyst Matt Burnell – no one is claiming the buybacks are going to get Goldman stock flying again.

“While the repurchase authority now amounts to about 16% of shares outstanding, we would not suggest that this is the net repurchase indicator that we have been suggesting would ultimately be the catalyst to revalue the shares higher,” writes Barclays Capital analyst Roger Freeman.

In part that’s because Goldman issues so many shares to its workers, who last year took home an average of $430,000, much of it in stock. The firm has spent $3 billion repurchasing almost 20 million shares this year, but its share count has fallen just half as much.

At that rate Goldman’s share count will resume declining over coming years, after a brief surge during the crisis as the bank raised capital. A falling share count will boost per-share earnings and book value (a measure of net worth) – but probably not fast enough to make the stock more appealing to risk-averse investors.

Further complicating matters is the role of regulators, who after their winning performance during the credit bubble are rightly intent on keeping the big banks from detonating the economy again. They want the biggest banks to keep more capital on hand. That means giving less to shareholders in dividends and buybacks, at least till the economic uncertainty lifts, which is looking like sort of a long shot at the moment.

The watchdogs must sign off on big banks’ dividend and buyback plans in advance, as Bank of America’s (BAC) Brian Moynihan found out the hard way. Both Goldman, which lately is stressing how responsible it is to hold lots of capital, and its analyst followers are cautious as a result.

“We believe any such action is likely to occur later in the year or 2012,” Freeman writes, and if so “we would expect GS to be an opportunistic buyer of its shares as opposed to mounting a public, defined share repurchase.”

Even if the Fed does sign off on a bigger repurchase plan, it’s easy to see why Goldman would rather do other things with its money. Unless its shares drop sharply, which the firm would surely see as less than ideal anyway, Goldman adds little to its value by spending money on repurchases – which only makes its declared goal of earning 20 cents on every dollar of invested shareholder money that much more demanding.

But the story of the nonrecovery recovery is one of lots of people with lots of cash and not a whole lot to do with it — so it’s only reasonable to expect more buybacks from Goldman, regardless of how much they move the share price.

“We think we can buy back what makes sense for us to buy back over the rest of the course of this year,” Viniar said last week. “We will calibrate that based on performance, share price, the environment and a bunch of other things. But I think we’ll be reasonable in our buybacks.”

Moving on: This is my last post for Fortune. After almost four years I am leaving to edit banks coverage at the Wall Street Journal. My thanks to the many people at Fortune and CNNMoney who made the blog happen, if you will — and most of all, of course, to our readers.