As of late, companies reinvesting capital to buy their own stock
has been on the rise. But is it always a win-win for
Last year, S&P 500 companies (NYSEARCA:SPY) made $398.9
billion in share repurchases and this year, buyback programs are
running nearly double, according to some estimates.
Corporations reduce their outstanding share count via stock
buybacks. Often, buybacks will occur over a period
of years and management will usually issue a statement like,
"Investing in our own stock is a good investment." More on that in
Which industry sectors have the highest buyback activity?
"The Information Technology (NYSEARCA:XLK) and Health Care
(NYSEARCA:XLV) sectors spent the most on quarterly repurchases
($19.8 billion and $14.4 billion, respectively) in Q4 2012.
However, of the sectors that averaged $2 billion or more in
quarterly share repurchases since 2005, the Industrials
(NYSEARCA:XLI) sector showed the largest sequential and
year-over-year growth (30.6% and 59.4%) in dollar-value
The peak in corporate share buybacks was reached back in 2007,
when companies bought $589.1 billion worth of stock.
"For 2013, S&P Dow Jones Indices anticipates that companies
will continue to protect their earnings by buying back the number
of shares necessary to prevent earnings dilution - something not
difficult to do given record levels of cash on hand," said Howard
Silverblatt, Senior Index Analyst at S&P Dow Jones Indices.
While buyback equity indexes have easily outperformed major stock
benchmarks like the Dow Industrials (NYSEARCA:DIA), not all of that
money is always well spent.
From 2004 to 2011, around $2.7 trillion was spent
by S&P 500 companies on share buybacks, according to
. The report concluded, "Using our Stock Buyback Scorecard we
find only 180 companies that were able to generate a return above a
7% cost of equity and just 98 companies that beat simple dollar
cost averaging. As a result it looks like most of the buybacks by
the S&P 500 over the past eight years have not yet added much
value for remaining shareholders."
With stock prices up sharply since 2009, share buybacks at any
price have looked smart. However, once stock
prices correct, we will find out which companies went
overboard with buybacks.
Potential Positives of Share Repurchases
Here are the potential benefits of share repurchase programs:
--Shows corporate management's conviction in the company
--Reducing share count through buybacks increases earnings per
Potential Negatives of Share Repurchases
Now, let's examine some pitfalls of share buybacks:
--Tempts management to pad their compensation by massaging EPS
numbers, which are in turn linked to pay
--Corporate managers buying company shares at the wrong price is
always a risk
--Use of leverage (borrowing) by companies to for stock buybacks
also increases risk
Undoubtedly, companies that consistently buy their own stock at
low prices help shareholders to get ahead. But too few management
teams have been able to do that. Berkshire Hathaway's Warren
Buffett is a rare example. Over the decades, Buffett has preferred
to use corporate cash for buybacks versus paying
How can investors measure the effectiveness of buybacks?
One way to measure whether companies are making prudent buybacks
is to compare the valuations at which they payfor their own shares
to the stock's historical median valuation.
Two ETFs focused on the share repurchase strategy are the
PowerShares Buyback Achievers (NYSEARCA:PKW) and the TrimTabs Float
Shrink ETF (NYSEARCA:TTFS). The latter screens out companies that
dilute shares or that overleverage to buy their own shares.
The May 2013 issue of the
Profit Strategy Newsletter
examines the fundamental and technicals for ETFs linked to major
asset classes. It includes our short list of mega investment themes
along with our popular Technical Forecast that's updated several
times per week.