Carol Loomis wrote about the benefit of buybacks in 1985:
Working with the 1,660 stocks covered by the Value Line Investment Survey, we identified companies that bought significant amounts of their own common stock in the ten years from 1974 through 1983. Next we reduced this list to voluntary repurchasers — cutting out, for example, companies that had bought the shares by paying “greenmail” to get rid of a threatening shareholder. Then we measured the total returns (stock appreciation plus dividends) earned by shareholders from the approximate dates of each repurchase “episode” to the end of 1984…
The outcome is spectacularly decisive. The shareholders in the buyback companies earned superb returns, far exceeding those accruing to investors as a whole. For all episodes measured, the buyback companies showed a median total return, expressed as an annual average, compounded, of 22.6%. The equivalent return for the S&P 500 was only 14.1%. That difference of 8.5 percentage points is enormously significant to an investor.
This information has been floating around ever since and the research shows the strategy still works.
The reason comes down to basic math. Buffett calls it smart allocation:
The obvious point involves basic arithmetic: major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, that value. When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended.
The other benefit of repurchases is less subject to precise measurement but can be fully as important over time. By making repurchases when a company’s market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management’s domain but that do nothing for (or even harm) shareholders. Seeing this, shareholders and potential shareholders increase their estimates of future returns from the business. This upward revision, in turn, produces market prices more in line with intrinsic business value. These prices are entirely rational. Investors should pay more for a business that is lodged in the hands of a manager with demonstrated pro-shareholder leanings than for one in the hands of a self-interested manager marching to a different drummer.
As to that other research…
What Works on Wall Street – A chapter is dedicated to buyback yield. Companies with the highest buyback yield outperformed the market by roughly 3% annually. The lowest buyback yielders (basically, net issuers of stocks) performed worse than the market.
When studying the most effective way to return cash to shareholders, repurchasing shares in the open market provides higher returns than paying cash in the form of dividends… All in all, buyback yield is an excellent factor to look at when determining a stock’s relative attractiveness.
Combining buyback yield with other factors produces similar market-beating results. Companies with the highest shareholder yields (another chapter) — labeled as buybacks plus dividends — beat the market by about 3%, while the lowest yielders lost to the market.
Both buyback yield and shareholder yield are good performers and should be considered by both value investors who want the best buy-back yield and shareholder yield and by growth investors who want to make certain to avoid the risks associated with the bottom decile of each group.
Shareholder Yield – I summarized the book several years ago. The results are the same. The highest buyback yielders beat the S&P 500 by slightly more than 2% annually. But when buybacks were combined with dividend yield and debt reduction, the outperformance rose to roughly 4%.
Quantitative Value – Buybacks are briefly touched on, but the summary is the same:
Many studies have found stock repurchases to be predictive of market-beating returns. The corollary is also true. Stocks issuing shares tend to underperform the market. There are two events to consider: (1) the announcement itself, and (2) the actual buyback or issuance. The utility of the buyback announcement is in its signal to the market that the business is healthy enough to commit capital to buying back stock, and also, with some allowances, that management considers the stock to be undervalued. The converse is true for stock issuance.
And a few others:
- Market Underreaction to Open Market Share Repurchases – “We find that the average abnormal four-year buy-and-hold return measured after the initial announcement is 12.1 percent. For “value” stocks, companies more likely to be repurchasing shares because of undervaluation, the average abnormal return is 45.3 percent.”
- On the Importance of Measuring Payout Yield – the combination of buyback and dividend yield (referred to as payout yield) is a better predictor of returns than dividend yield alone.
- Why US Investors Should Look Beyond Dividend Yield – looks at buybacks plus dividends in combination with other metrics like value, quality, etc.
Keep in mind, because some companies use buybacks to offset shares issued via stock options, you want to find companies actually reducing outstanding shares. The latest trend to use debt to fund buybacks is another thing to consider.
As some of the above research shows, using buybacks in combination with other factors works better than considering buyback yield on its own. Investors have two options: use net issuers of stock as an avoidance filter in an existing strategy to help reduce mistakes or use buyback yield as an added checkbox to improve on an already good strategy.
- The Laws of Investing – M. Housel
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- Mind the Gap 2019 – Morningstar
- The Never-Ending Ratchet of Conspicuous Consumption – S. Godin
- Jeff Bezos: The Electricity Metaphor (video) – TED
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