Until now the case for corporate stock buybacks has rested
far more on faith than data. Whenever a company seems to
lack better opportunities, its CEO or CFO will be pressured by
investors to buy back stock, or will anticipate such demands by
announcing a buyback program, on the assumption that reducing
the supply of outstanding shares will send the stock price up.
And that it often does. But are buybacks always the best
allocation of shareholder capital? Absolutely not, a new study
of buybacks shows.
fact, return measurements that are typically applied to capital
expenditures, mergers angod acquisitions and virtually every
other use of corporate capital are rarely used to measure the
value of buybacks, even though they consume equal or greater
amounts of corporate capital.
The prevailing wisdom in favor of them has rested on one or
more of the following rationales: 1) Buybacks provide
management with the flexibility to cash in gains or leave
capital invested; 2) The tax consequences of the alternative
for returning capital to shareholders dividends
are onerous; and 3) Buybacks automatically produce higher
earnings per share (although this is purely a mathematical,
non-operating result and overlooks the increase in risk that
the leverage accompanying the reduction in equity may
However, actual measures that analyze the returns or losses
that buybacks generate on invested capital are rarely
marshalled as evidence to back up such claims. Buybacks
are probably the least analyzed tangible event that companies
spend so much money on, says Jim Morrow, Fidelity
Research Equity Income Fund portfolio manager.
Theres a lot of room to illuminate the
effectiveness of buybacks.
Institutional Investors 2012 Corporate
Buyback Scorecard does just that. Compiled by Fortuna Advisors,
a New York City-based consultancy, the study ranks the biggest
spenders on buybacks among the members of the S&P 500 based
on the two-year returns their repurchases generated, as of last
June 30, a period when stock repurchases exceeded dividends by
more than two to one for all S&P constituents. The 253
companies bought back at least 4 percent of their market
capitalization, which Fortuna deemed a minimum amount to be
material. Using an approach much the same as any that investors
employ to measure returns on other corporate investments, the
rankings are based on the total return on cash expended on
buybacks during that period, taking into account dividends
avoided and the average value of shares at the end of each
Hallelujah, weve been looking for something like
this, says Tom Kolefas, Manager of the TIAA-CREF Mid-Cap
Value Fund. It opens a window on share repurchases just
as we, and the Street, require a return on acquisitions or
capital expenditures. You cant just say it was accretive.
It has to post a satisfactory return on invested
To illuminate how companies achieved their ROI, the rankings
also measure how effective the companies have been in timing
their purchases. Quite obviously, the more cash a company
spends before its stock rises and the more it rises, the higher
its ROI will be. But the study reflects wide variations in
timing and results, a surprising outcome given
managements freedom in this case to exploit inside
information about its revenue, cash flow, earnings and other
measures of corporate performance that shareholders care
Those variations are apparent in the studys measures
of buyback strategy, which compares total shareholder returns
with the average prices of shares in the prior quarter, their
dividends and ending quarter average price, and of buyback
effectiveness, which compares the difference between a
companys ROI and its strategy. Companies that tend to
repurchase shares when the stock price is lower than the
overall trend demonstrate positive effectiveness, whereas those
that tend to repurchase shares at prices higher than the
overall trend demonstrate negative effectiveness. At heart, the
studys formula shows ROI to be the sum of strategy and
Among the highlights of the studys findings:
The median buyback cost $1.18 billion and produced
ROI of 7.7 percent. Across all 24 sectors, Telecommunications
Services led the way with a collective buyback ROI of 38.7
percent. At the low end of the spectrum, technology
hardware & equipment (-12.3 percent) trailed other
More than half of the 253 companies that bought back
at least 4 percent of their market cap recorded a negative
buyback effectiveness, indicating that managers generally time
Sorting all 253 companies by their volume of buybacks
as a percentage of market cap, the median buyback ROI was 5.5
percent for companies in the top half versus 9.5 percent for
those in the bottom half. Perhaps underscoring the challenge of
timing larger buyback volumes, the only company with buybacks
that exceeded half the value of their current market
capitalization was Safeway at 72.9 percent. Its buyback ROI was
negative 9.2 percent.
A typical company uses a hurdle rate of about ten
percent when examining new investments. Logically, buying back
shares should be held to the same standard. However, 115
companies had a higher buyback ROI and 138 were lower.
Comparing two-year aggregate buyback ROI though June
2012 to the two years ending in Q2 2010, a 4 percent increase
in buyback ROI trailed the stock market. Meantime, buyback
effectiveness slipped by about 10 percent.
Individual performances also produced some
surprises. Goldman Sachs has a reputation for the
shrewdest market judgment on Wall Street. Yet its $9.8 billion
produced a buyback ROI of negative 20 percent the
worst in class. Both Goldmans buyback strategy and
effectiveness were also negative.
A 115 percent internal rate of return secured first place
overall for Sunoco, where $313 million in buybacks outpaced
$131 million in dividends distributed over the same period.
These buybacks rode a generally rising share price
reflecting a strong buyback strategy. And effectiveness was
over 60 percent, an indication that management also executed
their buybacks with share prices generally below the prevailing
In dead last, on the other hand, was Netflix, with more than
half of its $257 million spent to repurchase stock vanishing.
Management bought back most of the shares during a run up in
their share price and then reduced buybacks when the shares
fell, landing the company in negative territory for both
strategy and effectiveness.
The studys authors concede that an element of luck is
involved here. Who, after all, can predict with certainty when
executing buybacks whether the price will go up or down? But
market volatility also affects other investments on which
shareholders judge managers, including capital investments,
R&D pipelines and acquisitions. Ultimately what
matters is the return on your buyback. Its no different
from returns on other assets, says Fortuna CEO Greg
Yet investors often wont hear about returns on
repurchases from companies that spend lavish sums on them.
Take, for example, seventh place Biogen Idec, a global
biotechnology company. Readers who search its latest 10K for
comment on buybacks will find that Biogen Idec paid $2.6
billion to repurchase 40.3 million shares in 2010 and 6 million
shares in 2011 under authorization in February 2011 to
repurchase up to 20 million more shares. But any measure of
return is left for investors to calculate.
Ingersoll Rand, an Ireland-based multinational that competes
in the worldwide market for products and systems that protect
property and air quality, garnered 16th place overall and first
place in the capital goods sector after spending $1.2 billion
to repurchase shares. That price tag was the largest single
line item on Ingersolls 2011 statement of cash flows,
nearly twice the next biggest item, $646 million for a
loss on sale/asset impairment, and just under five
times capital expenditures. Nevertheless, its 10K reports
authorization by the board to repurchase 2 billion shares
without further comment as if the merits of a massive
buyback are self-evident.
In some cases, managers may be padding their own pockets
through ill-timed buybacks. In a paper entitled Insider
Trading via the Corporation and published last August,
Harvard Law Professor Jesse Fried cited overwhelming
evidence that insiders use private information to have firms
secretly buy and sell their own shares at favorable prices. The
volume of such indirect insider trading likely totals tens or
hundreds of billions of dollars per year. The upshot?
On average, public investors lose, and insiders
systematically profit to the tune of several billion
dollars per year, Fried wrote.
Whatever the explanation for ill-timed stock repurchases,
investors now have a tool with which to hold executives
feet to the fire over their decisions.