Don't Use Buyback Yield As Retirement Income Indicator

by: Richard Shaw

We recently wrote an article critical of "buyback yield" as a measure of shareholder return. We argued that while share buybacks due concentrate earnings at the time of the purchase, they do not necessarily create long-term value, and sometimes (often?) create negative value.

NYU professor Aswath Damodaran recommends looking at "augmented dividends" (augmented dividends = dividends + stock buybacks). Some have called buybacks the "invisible dividend."

We agree with Damodaran, if the valuation and prospects of the company are right, but they often are not - so we point out that cash dividends are a certainty, and the benefit to shareholders of buybacks are uncertain. You also have to dig a bit to see what is really happening - for example, to make sure the buybacks are more than just compensating for the dilution caused by executive stock option bonuses. Be careful when using and interpreting buyback data.

Mebane Faber recently published a book called "Shareholder Yield" presenting the combination of cash dividends, buybacks, reinvestment and acquisitions as a potentially better way to look at yield than just cash distributions.

He points out that the "shareholder yield" concept only makes sense for stock buybacks when the shares are selling at less than their "intrinsic value."

We agree with him on that point, but don't believe that there is a universally valid measure of intrinsic value. It is not just a matter of valuation multiples and involves judgments about the future.

Public companies have not proven that they are necessarily good at that judgment when it comes to their own stock.

You need to make sure that you also think the price of the stock is below intrinsic value and not just rely on the assumption that management would only buy back if they think intrinsic value justifies it. Managements have numerous forces and biases, and self-interest conflicts that can cause them to buy back their stock at the wrong time.

If buybacks result in long-term earnings accretion, and if the company has a consistently applied dividend payout ratio policy, buybacks would be advantageous to equity income investors. Unfortunately, the practice does not live up to the theory in many (most?) cases.

"Institutional Investor" pointed out in a recent article that buybacks often disappoint investors, basically poring cold water on the popularized idea of buyback yield.

Yardeni Research also recently published a report that contains a chart showing that S&P 500 executives aren't much better than the average Joe at market timing for their share repurchases.

That chart reproduced here with permission shows that S&P buybacks climbed steadily as the index rose in price from 2003 through 2007, then declined during the 2008-2009 crash, and then rose again as stock prices recovered - exactly the opposite of buy low, sell high - just like the average so called "dumb money" retail investor. Looks like corporate executives in the end are just regular Joe's too.

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FACTSET made a similar observation.

The "buyback yield" can be obtained and charted by subscribers to, which can produce charts such as this one for specific companies. You can also plot a number of fundamental dimensions at YCharts that could be helpful to you in making your own determination about the intrinsic value of the shares a company is repurchasing.

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It is worth looking into specific company buybacks to make your own judgment about the wisdom and benefit of purchases, but not to take the measure hook, line and sinker as a measure of benefit to shareholders. You have to do a lot of homework if you want "buyback yield" or "augmented yield" or "shareholder yield" to be a stock selection tool.

Keep in mind as the Institutional Investor article and the Yardeni and FACTSET charts show large companies in the aggregate appear to do more buybacks when prices are high when they should be issuing more shares, and do fewer buybacks when prices are low when they should be repurchasing shares. They apparently haven't been getting intrinsic value calculations right for a long time now.

Buyback yield can make sense on a company-by-company basis, if you do your homework, but on an aggregate stock market basis, not so much.

And finally, for those investors who require income generation from their stock allocation to support their retirement while avoiding sale of volatile assets at inopportune times, only cash dividends are actual yield. Those other "yields" are constructs aimed at gauging future overall stock performance -- only cash is cash when it comes to portfolio income.

A few examples of ETFs directly relevant to aggregate stock market buyback behavior are those following the S&P 500 (SPY and IVV) and the Russell 1000 (NYSEARCA:IWB).

Example dividend ETFs containing large-cap companies that may have significant buyback programs: S&P 1500 Dividend Aristocrats (NYSEARCA:SDY), Dow Jones Select Dividend (NYSEARCA:DVY), NASDAQ Dividend Achievers (VIG) and FTSE High Yield Dividend (NYSEARCA:VYM).

Disclosure: QVM has positions in SPY, SDY, VIG and VYM as of the creation date of this article (June 27, 2013). We certify that except as cited herein, this is our work product. We received no compensation or other inducement from any party to produce this article, but are compensated retroactively by Seeking Alpha based on readership of this specific article.

General Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.