Buybacks: Not All They're Cracked Up to Be 9 comments
January 06, 2009
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Excited about a big new buyback? Companies such as Microsoft (MSFT), IBM and Exxon (XOM) had some of the largest buyback announcements in 2008. However upon closer inspection, an announcement, or rather authorization, is not always an indication of corporate spending. As highlighted by the chart below, public corporations have been more and more interested in buying back their own shares, but the announcements have grossly exceeded the actual purchases.
click to enlarge
As shown, only 72% of the total authorizations were completed in 2008; and looking back further to the bear market of 2000, that number was closer to 50%. Authorizations were down sharply in 2008, and completed buybacks will likely follow the same trend.
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On Jan 06 08:33 PM GolfBargainHunters wrote:
> Buybacks usually are not a good use of a company's capital. They
> purchase shares to offset executive stock options and the such. Also,
> company's usually buy shares at the wrong time, when they are fully
> valued, or even overvalued. It would be more shareholder friendly
> to disperse the cash to shareholders, and let them decide how best
> to use the cash, not fund the executive's.
one year returns prove absolutely nothing. buying back shares permanently shrinks a firm's capital base and increases leverage. if you think there is no risk to doing this you do not understand finance.
ponder this:
aggregate stock market returns over the last 10 years have been approximately zero. what does this suggest about aggregate share buybacks during this period? it suggests that it has been a singularly foolish waste of one of the most precious resources a company has...its capital. it cannot be issued on a whim and, in some markets....today's for example...it is nearly impossible to raise.
golfbargainhunters is absolutely correct: companies typically buy shares back after a successful run when they're flush with cash...exacxly the wrong time to do it. i can name many companies today...nearly any retailer or financial institution, for example...who would be wise to consider share buybacks given the carnage in their share prices over the last year but they can't do it because they desperately need the capital.
the author is spot on. if they can't reinvest their profits to grow the business let them pay dividends. buybacks are for idiots who don't know any better.
On Jan 06 09:50 PM AJB7 wrote:
> This opinion is not supported by the facts. Research has consistently
> shown that companies with the largest one year reduction in shares
> as a group outperform other stocks, with one recent study showing
> the top quintile earning a positive excess return of 3.1% vs the
> bottom quintile earning a negative excess return of 5.2% over the
> 1991-2007 period.
i have no objection to limited buybacks for a specific purpose, e.g. to fund stock plans for employees. but the notion that broad, regular buyback programs somehow serve shareholders is a fiction propogated by self serving companies who don't want to pay dividends because it locks them in to a shareowner commitment....period. any shareowner who believes this is a good use of capital is ignorant of corporate finance.
On Jan 07 12:39 AM Anthony Alfidi wrote:
> Buybacks can be a useful tool for a CFO of a healthy company. Younger
> companies can use them to return cash to investors in lieu of declaring
> a dividend, thus retaining their cache as a growth stock. Institutional
> investors like them because they help counter the dilution that results
> when the company's insiders exercise stock options or collect share
> grants.
The one (and only to my knowledge) study that did not show value added by buyback companies as a group was done by Standard & Poor's and covered 2006 and the first half of 2007. Researchers as well as long term investors may well not want to overturn findings that have been true for three or four decades based on eighteen months of recent performance. Still, I suppose it is possible that some paradigm shift has begun and the juice has been squeezed out of this market inefficiency.
Incidently, I was speaking of share buyback companies as a group, but of course any individual company is another matter. Studies have also shown that share buybacks in context of insider selling or certain use of discretionary accruals, among other things, are red flags for future company performance and these stocks should be avoided.
But perhaps, as the S&P study initially suggests, there has been a risk myopia bubble that has recently infected a broader swarth of companies on the buyback issue. No doubt this will be looked on in the future as one aspect of the broader value distortion in other financial areas during the last few years. But if it is a bubble, then it is likley to be a passing phase I suspect. Only time will tell.
i am in no position to challenge the studies you mention. they would be an interesting read, for sure. i would be most curious as to how they would measure success of a buyback program. if it's share performance over time, how could the singular effect of a buyback on share prices be isolated? i assume that it would require comparison to a control group where buybacks did not occur but there are so many variables that determine share prices i just don't see how any such study could be definitive. markets are dynamic...P/E expansion or contraction alone occurs constantly...in different market periods and in different industries, driven by a host of variables including interest rates, investor sentiment, economic data, etc. neither does it make intuitive sense to me that one could broadly conclude...study or no study...that companies that buy back their shares consistently outperform. it requires belief that these companies can time repurchases for optimum performance and do it regularly. i'm very skeptical.
one way...maybe the only definitive way...to prove the efficacy of a buyback program is to compare over a lengthy period the weighted average share price of stock purchases against the current share price. but even that type of analysis is limited. the true effect of a buyback must take into consideration the effect on both earnings, cash flow and dividends of the period studied. but neither would it include opportunity costs. should apple have repurchased shares instead of focused on product development that gave birth to the i pod and the i phone? obviously not. and even if the period of measurement were sufficiently lengthy to capture market cycles, the positive effects of buybacks, to the extent they occur, can disappear overnight if either the company risk profile (i.e. securities risk) or securities markets (i.e. market risk) deteriorate meaningfully. we've seen the most extreme example of this since the great depression in the collapse of our very financial system. the major banks...thought to be rocks of gibralter just a couple of years ago...today can't raise equity capital. either it is be prohibitively expensive or not even possible because there are no buyers.
this leads to my primary objection about buybacks, which has nothing to do with their effectiveness and everything to do with stewardship of the business. i believe:
1. capital is precious and it should be safeguarded. it should be regarded as permanent.
2. managements rely too much on financial gimmickery to boost share prices when they should be directing their efforts to developing the business. this has been particularly true in the last 20 years or so.
3. the practical way to reward shareowners is through dividends. it puts real cash in shareowners pockets and if the company runs into trouble the dividends can be reduced or revoked.
i've worn out my welcome on this issue. but thanks for hearing my views.
On Jan 07 11:19 PM AJB7 wrote:
> Response to Icandoitdon: The study I was specifically refering to
> is Richard Tortoriello's Quantitative Strategies for Achieving Alpha,
> but there are numerous studies dating over the past 20 years that
> have confirmed this finding including those by Josef Lakonishok,
> Theo Vermaelen, and David Ikenberry. More recent studies continue
> to confirm these findings (eg Peyer and Vermaelen, 2005 and Gup and
> Nam, 2005).
>
> The one (and only to my knowledge) study that did not show value
> added by buyback companies as a group was done by Standard &
> Poor's and covered 2006 and the first half of 2007. Researchers as
> well as long term investors may well not want to overturn findings
> that have been true for three or four decades based on eighteen months
> of recent performance. Still, I suppose it is possible that some
> paradigm shift has begun and the juice has been squeezed out of this
> market inefficiency.
>
> Incidently, I was speaking of share buyback companies as a group,
> but of course any individual company is another matter. Studies have
> also shown that share buybacks in context of insider selling or certain
> use of discretionary accruals, among other things, are red flags
> for future company performance and these stocks should be avoided.
>
>
> But perhaps, as the S&P study initially suggests, there has been
> a risk myopia bubble that has recently infected a broader swarth
> of companies on the buyback issue. No doubt this will be looked on
> in the future as one aspect of the broader value distortion in other
> financial areas during the last few years. But if it is a bubble,
> then it is likley to be a passing phase I suspect. Only time will
> tell.
>
>
>
>
>
The balance sheet should reflect the accumulated wealth of the corporation over its life. The book value per share should reflect a fair accounting of that corporation's base worth. The more earnings power it has, the higher multiple it should trade at over its book value. If you wanted to be really conservative, you could use tangible book value --- (depending upon the company and its industry and what sort of intangibles are on the books and at what value, I guess).
IMHO, a share buyback only makes sense if and when the market drives the stock's price down below book value per share. Whenever that happens, the company can buy its shares out of the market and deliver an immediate return to its remaining shareholders on whatever money is spent. One dollar out of the bank equals $1.25 added to book per share, for example. A no-brainer, I think.
But the original comment was spot on, in my experience. For the 8 years I've followed stocks, it seems that companies tend to institute buybacks at the absolutely worst times. Generally, after a huge run-up and when the market value of their stock is way over what it should be (or its long-term trend value is). That's a total waste of resources and money. JCP buying their shares back at $80+ was a mistake. They could have waited, and taken 4 times as many shares off the street for that same amount of money. Same with Sears buying their shares back at $180. And the list goes on and on and on. Smart companies don't buy their shares when prices are high; they buy their shares when prices are low. When the price is high, they should be ISSUING shares - not buying them back. (But only if they have a legitimate need and productive use for the extra money.) I've come to take a share buyback announcement as a "sell" signal, since every company I've seen buying their shares back is waaaaaayyyyy lower 12 to 18 months later. Without exception.
If the CFOs were smart, I think they'd be taking all that excess cash they had when times were good, and paying it in dividends as suggested. Or better yet, paying down debt. Every dollar paid on debt also delivers an immediate return to the shareholders, in an amount equal to the interest saved. And little or no debt, with loads of cash in the bank, would serve the company well in difficult times like today. While all the other companies are struggling, they could be swooping in and buying up their competition for only pennies on the dollar. Or branching out into high-potential areas on the cheap.
This whole stock compensation thing irks me, too. Stock isn't a payroll tool, and it never should have become one (with the possible exception of start-up companies with negative cash flow that have no other way of paying their employees). Pay the employees and executives in cash. And if they want to be an owner as well as an employee, then they can buy their shares in the open market like everyone else. And why would a company want to buy shares back at the same time that it is issuing them left and right to employees and executives?