Market Edge Report: Stock buybacks part II

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Market Edge Report empowers the self-directed investor . Each report investigates a single market metric in depth. We don't just give you numbers, we show you where to find them yourself, suggest what you might want to watch for, and offer some perspective as to what it all means.

Part Two: Using stock buyback data to make better trades

In part one of the report I focused on why and how stock buybacks increase share price. If you aren't familiar with that why and how, that's the place to start. Now we are getting into market strategy. First, understand that a stock buyback plan is a forecast on the part of a company's management that the company cannot safely expand as fully as its profits would allow it to if the world were of infinite size. For mature companies, this is a reasonable assessment - it makes no sense for growth companies unless some unusual force (an investigation by the Justice Department, for example) is preventing growth.


That isn't rocket science, but you will note that even if that is all you know, you know enough to make some judgement calls. Sometimes a company gives the Street aggressive growth targets in its quarterly guidance but chooses to spend most of its cash on stock, rather than expansion. That means the company isn't putting its money where its mouth is, and every shrewd investor knows to follow the money, not the mouth.

Of course, few cases are so clear cut, and while stock buyback information won't normally tell you which individual companies to buy, it is very useful if you wish to take the temperature of an entire industry - or the entire market. Consider the chart below, from FactSet .

In Q4 2013, companies spent $126 billion on share buybacks. (For comparison, companies spent $80.6 billion on dividends during the same quarter.) This amount was a 25% increase over the year-ago quarter, but essentially unchanged from the previous two. Looking back, we can seen that the dollar amount being spent on share buybacks more than doubled in the three years leading up to the financial crash, confirming the logical supposition that spending a lot of money on share repurchasing is a company's way of telling the market that it sees trouble brewing.

Now, consider the chart of Q1 2014, also from FactSet .

It turns out that there was a very steep increase in spending on share repurchases during the quarter. Companies spent $154.5 billion on their own shares - a 50% increase from the year ago quarter and a substantial increase from the previous quarter. (For comparison, companies spent $90.5 billion on dividend payments during the same quarter.) Though I remain a perma-bull at heart, this large increase gives me pause. The rise in Q1 2014 actually bears more than a passing resemblance to the rise in Q1 2007.

But you didn't read this far just to hear general market doom-saying. Let's have a look at which industries have been doing the most stock-stroking. Consider the chart below from the FactSet report, which compares the spending in the most recent quarter to the historical average for the sector.

It turns out that the biggest culprit by far is the Information/Technology sector, which spent a huge $47.4 billion on its own shares in Q1 2014 - almost twice what it usually spends. Look a bit closer and you'll also note that the financial industry was relatively sparing in its use of stock buybacks. That company's the work with money can find better uses for their money in encouraging, and suggests that there must still be some good investments out there somewhere. For now, however, it might be prudent to tread lightly in Information and Technology.


This article was originally published on MarketIntelligeneCenter.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.




This article appears in: investing , Technology

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