In today's low-yield environment, investors prefer
. The valuations of most
are reasonable, but there are few opportunities that offer really
Conversely, companies buying back shares don't get the same
attention and valuation premium.
But it should. Share buybacks can create incredible value. Let
me show you how:
When a company implements a share buyback, a few things
happen. First, the buyback reduces the number of shares
outstanding. Second, earnings get divided among a smaller
number of shares. In turn, earnings per share grow, which
often sends the share price higher.
Stock buybacks also have an added benefit of being a tax-free
way to return cash to shareholders. That's because - unlike
dividends - share buybacks aren't taxed as shareholder
Now, stock buybacks are nothing new. Recently, S&P 500
companies bought back large amounts of stock. In the last 12
months, buybacks total $400 billion. That means they're spending
70% of their cash flow on stock buybacks.
The criticism of most share buyback programs is that
executives initiate them at the wrong time. In good times, when
companies are flush with cash, executives buy their stock even
when the valuation is at a premium. And buying an overvalued
stock is always a very poor use of cash flow.
And that's why valuation is crucial. For investors, the recipe
for profits is to own companies conducting big share buybacks
that also trade at an inexpensive valuation and have decent
Research from BMO Capital Markets indicates that the 100
companies with the largest stock buybacks beat the market. Their
total annual return of 14.2% beats the benchmark by 50%.
And the report found that
companies doing buybacks performed even better - returning 17.9%
. The satellite television company bought back 57% of its shares
since 2006. That helped fuel earnings growth, and sent the stock
from $15 in 2006 to $58 today - a 293% increase.
And DirecTV continues to buy back its shares. The company is
authorized to buy back $4 billion of stock. Shares trade at
12-times trailing earnings. Compare this to the trailing PE of 19
for the S&P 500, and it's clear that DirecTV executives are
buying back a cheap stock.
DirecTV isn't the only company with a big share buyback
program and an inexpensive stock.
is buying back $60 billion of stock and trades at 12-times
earnings. Or consider
Northrop Grumman (
- both bought back 10% of their shares last year, and also trade
at just 12-times earnings.
The good news is that investors don't usually need to choose
dividends or share buybacks. That's because most companies with
large share buybacks also pay a dividend.
My advice - don't discount the power of the share buyback when
evaluating an investment. In fact, the aggressive buyback of
cheap stock will likely fuel most of your investment profits.
Full Disclosure: I own shares of DirecTV in a personal