As of late, companies reinvesting capital to buy their own stock
has been on the rise. But is it always a win-win for shareholders?
(NYSEARCA:SPY) companies 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 a minute.
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
(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 a Credit Suisse study.
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
(INDEXSP:.INX) 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:
- They show corporate management's conviction in the
Potential Negatives of Share Repurchases
- Reducing share count through buybacks increases earnings per
Now, let's examine some pitfalls of share buybacks:
- They tempt 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.
(NYSE:BRK-A) Warren Buffett is a rare example. Over the decades,
Buffett has preferred to use corporate cash for buybacks versus
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 pay for their own shares to
the stock's historical median valuation.
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.
Editor's note: This story by Ron DeLegge originally appeared on
To read more from ETFguide, see:
Bond Fund Managers Are Loading Up on Stocks
Inflation Vs. Deflation: Who's Winning?
Are Defensive Sectors Still Defensive?