icandoitdon

Buybacks: Not All They're Cracked Up to Be

thanks for your thoughtful post. i agree with most of the points you make.

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.
>
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