“When you start looking at stock buybacks, you begin to realize you are playing a game of Three Card Monty. Nothing is really as it seems and the numbers never really add up. It truly is dealing with the cards stacked against you”.
- Robert G. Warren
Several years ago I wrote about how many corporate executives buy back company stock at exactly the wrong time. They generally purchase as their share price hits an all-time high then cease all activity when the stock price crashes. I’ve always been cynical when corporate boards announce share buyback plans in the hundreds of millions (or even billions). After M&A activity, in general I can’t think of a worse use of capital.
Buybacks: A Quick History
Traditionally stock buybacks were not held in very high regard. In 1932, The New York Times made three specific arguments against buybacks. First, they used up a corporation’s cash balance. Second, they were simply a cash transfer between the corporation and management/directors who were dumping their shares. Last, they focused management on the whims of the market (through stock price movement) and distracted them from the running of the business. The Securities and Exchange Committee made it more difficult in 1934 with the Securities and Exchange Act making stock buybacks (though not mentioned) a potential violation.
The 1970’s provided middle ground by creating conflicting policy of either making buybacks flat out illegal to simply having a corporation disclose their intention to purchase their shares. The SEC never really came up with a good answer, flip flopping back and forth. Things took a big step in a different direction in 1982 with the SEC’s issuance of Rule 10b-18 which made it very difficult (if not impossible) to sue companies for stock buybacks. By removing mandatory disclosure requirements, companies received a green light to start buybacks with relative abandon.
Which brings us to today. The Trump tax cuts have brought buybacks into focus again. Indeed, buybacks - which have been increasing over the last decade - jumped about 50 percent last year to nearly $800 billion for the companies in the S&P 500. This is an all new high according to S&P Global. These data seem to contradict the claim that most of the tax cuts have gone towards reinvesting and growing company businesses. (Though to be fair some would argue share buybacks are a form of capital reinvestment). Since 2009 US companies have bought back roughly 80 billion shares, but total shares have increased from 289 billion in 2009 to 294 billion in 2019. It’s hard to argue that shareholders have been the winner in this binge of buying and lack of share reduction.
In fact, much research has been published showing that buybacks add little, none, or even subtracts value from shareholder returns. One of the most interesting – which I encourage readers to download (sorry to say there is a license of $44USD) – is an excellent peer reviewed article[1] outlining that in many countries - whether investors use a dividend model or a total payout model to decompose equity returns - net buybacks explain more than 80% of the cross-sectional dispersion of stock market returns.
Another example of repurchases changing in their scope and value for corporations versus shareholders has been the explosion in repurchases. In a study by David
Ikenberry Josef Lakonishok Theo Vermaelen (“Stock Repurchases in Canada: Performance and Strategic Trading”), the authors state:
“In recent years, corporations have dramatically increased the amount of capital devoted to repurchasing their own shares. In the mid-1980s, repurchase program
announcements in the U.S. amounted to roughly $25 billion per year. Between 1996 and 1998 however, more than 4,000 open market repurchase programs were announced which, if fully completed, amount to roughly $550 billion. During the first quarter of 1999 alone, Securities Data Company reports nearly 350 program announcements totaling $40 billion. Interest in corporate repurchase programs is not limited to the U.S. as repurchase activity worldwide has grown in recent years. Countries such as Hong Kong and Japan recently implemented new regulations allowing companies for the first time to repurchase their shares. A recent Goldman Sachs study (March 1999) foresees stock repurchases becoming more common in Europe and discusses the potential impact on European equity values.”
Why This Matters
With this explosion in repurchases – yet no reduction in share counts – the obvious question is whether these actions have been a wise allocation of capital. If the answer is yes, then shareholders should whole heartedly encourage such behavior. If the answer is no, then shareholders – through their duly elected representatives on the company’s Board of Directors – should actively seek to stop these transactions.
Investors should look at share repurchases as no different than their value approach in their own investment process. If shares are bought at a discount to the company’s intrinsic value then this could be perceived as an appropriate allocation of capital. Repurchasing shares at prices higher than intrinsic value would be a poor use of capital.
Unfortunately, all evidence would suggest that companies go on repurchasing binges as share prices reach new highs and cease purchases as share prices reach new lows. The most recent example of this has been the example previously cited with new repurchase highs reached in 2019 as shares reached all time highs. Another example was the similar pattern in 2006 – 2009 as share repurchases reached all-time highs (for the time) in 2007 (the height of the mortgage asset bubble) only to see a near 75% drop in repurchases as the markets collapsed in 2008 – 2009 (see graph below).
For any investor in a company that has followed this pattern of “buy high and stop buying when low”, they can safely assume management has a poor understanding of capital allocation. Any value investor should avoid companies run by such individuals.
Conclusions
The story of stock buybacks has been relatively consistent since the SEC’s policy change in the 1980s. The enormous number of buybacks – mostly purchased when stock prices are at all-time highs – have provided little to no advantage for the value investor. Only when enough shareholders speak up and force management – through Board oversight – to perceive stock buybacks as a means to improve shareholder returns will buybacks become sound capital allocation. As a value investor, I suggest readers find companies that have firm guidelines about buybacks which is tied directly to value versus intrinsic value. Partnering with such management gives an investor the best chance to see long term growth in their portfolio.
[1] “Net Buybacks and the Seven Dwarfs”, Jean-François L’Her , CFA, Tarek Masmoudi & Ram Karthik Krishnamoorthy , CFA, Financial Analysts Journal, December 12, 2018, pages 57 - 85
- Robert G. Warren
Several years ago I wrote about how many corporate executives buy back company stock at exactly the wrong time. They generally purchase as their share price hits an all-time high then cease all activity when the stock price crashes. I’ve always been cynical when corporate boards announce share buyback plans in the hundreds of millions (or even billions). After M&A activity, in general I can’t think of a worse use of capital.
Buybacks: A Quick History
Traditionally stock buybacks were not held in very high regard. In 1932, The New York Times made three specific arguments against buybacks. First, they used up a corporation’s cash balance. Second, they were simply a cash transfer between the corporation and management/directors who were dumping their shares. Last, they focused management on the whims of the market (through stock price movement) and distracted them from the running of the business. The Securities and Exchange Committee made it more difficult in 1934 with the Securities and Exchange Act making stock buybacks (though not mentioned) a potential violation.
The 1970’s provided middle ground by creating conflicting policy of either making buybacks flat out illegal to simply having a corporation disclose their intention to purchase their shares. The SEC never really came up with a good answer, flip flopping back and forth. Things took a big step in a different direction in 1982 with the SEC’s issuance of Rule 10b-18 which made it very difficult (if not impossible) to sue companies for stock buybacks. By removing mandatory disclosure requirements, companies received a green light to start buybacks with relative abandon.
Which brings us to today. The Trump tax cuts have brought buybacks into focus again. Indeed, buybacks - which have been increasing over the last decade - jumped about 50 percent last year to nearly $800 billion for the companies in the S&P 500. This is an all new high according to S&P Global. These data seem to contradict the claim that most of the tax cuts have gone towards reinvesting and growing company businesses. (Though to be fair some would argue share buybacks are a form of capital reinvestment). Since 2009 US companies have bought back roughly 80 billion shares, but total shares have increased from 289 billion in 2009 to 294 billion in 2019. It’s hard to argue that shareholders have been the winner in this binge of buying and lack of share reduction.
In fact, much research has been published showing that buybacks add little, none, or even subtracts value from shareholder returns. One of the most interesting – which I encourage readers to download (sorry to say there is a license of $44USD) – is an excellent peer reviewed article[1] outlining that in many countries - whether investors use a dividend model or a total payout model to decompose equity returns - net buybacks explain more than 80% of the cross-sectional dispersion of stock market returns.
Another example of repurchases changing in their scope and value for corporations versus shareholders has been the explosion in repurchases. In a study by David
Ikenberry Josef Lakonishok Theo Vermaelen (“Stock Repurchases in Canada: Performance and Strategic Trading”), the authors state:
“In recent years, corporations have dramatically increased the amount of capital devoted to repurchasing their own shares. In the mid-1980s, repurchase program
announcements in the U.S. amounted to roughly $25 billion per year. Between 1996 and 1998 however, more than 4,000 open market repurchase programs were announced which, if fully completed, amount to roughly $550 billion. During the first quarter of 1999 alone, Securities Data Company reports nearly 350 program announcements totaling $40 billion. Interest in corporate repurchase programs is not limited to the U.S. as repurchase activity worldwide has grown in recent years. Countries such as Hong Kong and Japan recently implemented new regulations allowing companies for the first time to repurchase their shares. A recent Goldman Sachs study (March 1999) foresees stock repurchases becoming more common in Europe and discusses the potential impact on European equity values.”
Why This Matters
With this explosion in repurchases – yet no reduction in share counts – the obvious question is whether these actions have been a wise allocation of capital. If the answer is yes, then shareholders should whole heartedly encourage such behavior. If the answer is no, then shareholders – through their duly elected representatives on the company’s Board of Directors – should actively seek to stop these transactions.
Investors should look at share repurchases as no different than their value approach in their own investment process. If shares are bought at a discount to the company’s intrinsic value then this could be perceived as an appropriate allocation of capital. Repurchasing shares at prices higher than intrinsic value would be a poor use of capital.
Unfortunately, all evidence would suggest that companies go on repurchasing binges as share prices reach new highs and cease purchases as share prices reach new lows. The most recent example of this has been the example previously cited with new repurchase highs reached in 2019 as shares reached all time highs. Another example was the similar pattern in 2006 – 2009 as share repurchases reached all-time highs (for the time) in 2007 (the height of the mortgage asset bubble) only to see a near 75% drop in repurchases as the markets collapsed in 2008 – 2009 (see graph below).
For any investor in a company that has followed this pattern of “buy high and stop buying when low”, they can safely assume management has a poor understanding of capital allocation. Any value investor should avoid companies run by such individuals.
Conclusions
The story of stock buybacks has been relatively consistent since the SEC’s policy change in the 1980s. The enormous number of buybacks – mostly purchased when stock prices are at all-time highs – have provided little to no advantage for the value investor. Only when enough shareholders speak up and force management – through Board oversight – to perceive stock buybacks as a means to improve shareholder returns will buybacks become sound capital allocation. As a value investor, I suggest readers find companies that have firm guidelines about buybacks which is tied directly to value versus intrinsic value. Partnering with such management gives an investor the best chance to see long term growth in their portfolio.
[1] “Net Buybacks and the Seven Dwarfs”, Jean-François L’Her , CFA, Tarek Masmoudi & Ram Karthik Krishnamoorthy , CFA, Financial Analysts Journal, December 12, 2018, pages 57 - 85
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