When important people on Wall Street and Capitol Hill are actively criticizing an aspect of corporate America, we’d better take notice. Share buybacks—the open market repurchase of a company’s shares by the company itself—have been under a lot of fire. The amount spent on buybacks is matching records, and that money would be better spend on capital expenditures, research & development, higher employee wages, and so on. So goes the now vitriolic anti-buyback argument.
What follows is a sober-as-possible assessment of where we stand with buybacks today.
- Who is doing them and in what true quantity (raw dollar amount is a useless measure of buyback intensity)?
- Do firms conducting buyback programs do so at exactly the wrong time (which is the current consensus), or are some firms quite good at timing the repurchase of their shares at fairly cheap relative prices?
- Can share repurchase programs be a useful tool for active stock selection?
First things first: the companies under consideration are all U.S. listed/domiciled public companies with a market cap higher than the average (this is about 750 stocks or so, with market caps higher than roughly $8 billion today). Most buybacks are conducted by larger firms, and larger firms represent a cleaner dataset for this analysis. Smaller firms tend to be raising more capital from stakeholders, whereas larger firms tend to be returning more capital to stakeholders.
Cash Spent on Buybacks
Sure enough, we are reaching peak dollar amounts on a rolling 12-month basis.
But this is a useless number. All that matters is the amount spent on buybacks relative to the size of the overall market. Here is the buyback yield (total buybacks over last 12 months divided by total current market cap) for the U.S. large cap market, in both gross (cash spent on buybacks only) and net (cash spent on buybacks minus cash raised through any share issuance). Net is the number that really matters. The yield of 2.1% is high but well below the early 2008 high of 3.6%.
The fairly smooth line at the market level gets much messier at the sector level. I have to separate it into a few graphs to be readable, so here break it out by cyclical and defensive sectors. Defensive first:
Note some goofiness. Telecom is just a few companies really so it’s all over the place. Utilities tend to be net issuers. Energy as a whole had one of the highest buyback yields in 2008 at more than 6% (whoops).
Even more extreme readings through history for cyclical sectors. The yield for Consumer Discretionary stocks nearly hit 8% at one point, and the yield on financials spiked negative due to massive share issuance during the hellhole of 2008/09.
So Does Any of This Matter For Investors?
Interesting stuff, but we have to remember that these charts are just aggregated data. What is more relevant for active investors is: have ongoing shareholders (those who don’t sell their shares back to the company as it is repurchasing shares) benefitted from the companies’ decision to buyback stock?
Here is the key point: the magnitude of buybacks is very important. A company which repurchases 10% of its shares in one year is much different than a company which repurchases 2%. Arguably, a higher buyback yield indicates higher conviction from the company in question that their shares are attractively value and/or they are being more disciplined in their allocation of capital (i.e. are spending a lot on buybacks due to a lack of attractive opportunities elsewhere). I know plenty of people who would take the opposite side of that argument. Luckily, we have data!
Let’s look at the valuations at which companies have tended to repurchase shares at varying levels of buyback conviction. I’ll define low conviction as buyback yields between zero and five. Higher conviction means buyback yields between five and ten, and highest conviction means buyback yields of ten or higher.
Next we calculate an independent valuation for each company on each date relative to all other large U.S. stocks (which gives us a percentile score 0-100, with 0 being cheapest). For this valuation, we use four factors: price-to-sales, price-to-earnings, free cash flow-to-enterprise value, and EBITDA-to-enterprise value. These factors are equally weighted in the calculation.
Armed with these two things, 1) companies bucketed by buyback yield and 2) relative valuation percentiles, we can see if companies tend to buy back stock at good relative prices or bad ones.
To see how the distributions look historically, let’s first compare the distribution of all large stocks by valuation percentile vs. companies that are issuing shares (negative buyback yield). The x-axis is the valuation percentile buckets, so anything on the far left, in the 0-5 bucket, is in the cheapest five percent of the market. The y-axis is the percent of the companies falling in each bucket.
As you would suspect, the line for large stocks is flat: our relative value score 0 to 100 is equally distributed. But the result for share issuers is different. What this chart shows you is that on average, companies tend to slightly mistime share issuance—issuers have tended to be a little more expensive that other stocks in the market, this the skew towards the right (expensive) side of the distribution.
Now let’s look at the same thing for varying levels of buyback conviction.
You see the reverse: that companies with higher conviction (5-10, and 10+ percent yields) have tended to, on average, buyback stock at much cheaper relative prices. In fact, the average valuation percentile is 33 or so (so in the cheapest third), when from a random sample you’d expect the average score to be 50. Companies buying back between 0-5% of their shares (which is far more common, and makes up most of the dollars spent on buybacks) don’t display nearly as strong a pattern.
Buybacks may not be well timed in aggregate, but they have been timed well (at least, timed at cheaper relative prices) by companies with the highest conviction buyback programs. These can get lost in the shuffle because, on average, the cash spent on buybacks by these high conviction firms represent 22% of the total cash being spend on buybacks (gross).
So are companies just issuing debt at low rates to finance share buybacks? Obviously it’s hard to say for sure. We can, however, test two different stock selection factors to estimate the impact on debt issuance or reduction in the most recent low interest rate environment.
We create two “shareholder yield” factors.
- First take all cash spent on buybacks, subtract all cash raised from issuance, plus all cash spent on dividends. Then divide by current market cap for a “yield.” (net bb + divs))/market cap
- Same as above, but now include net debt issuance/reduction, where companies paying down debt in addition to dividends and buybacks are ranked more favorably. (net bb + divs + net debt reduction)/market cap
We will call the first “shareholder yield” and the second “stakeholder yield” because debt is part of the equation. For these purposes, I am excluding financial stocks, because they use of debt is so much different from other sectors. In practice, you’d want to make sector specific adjustments to measurements of debt, but here I am just keeping things pretty simple.
Now let’s run at typical test of the returns for stocks in the top decile by these two yield factors. Both have been strong selection factors. Here is the rolling 3-year excess return earned since the late 1980’s by the highest “yielding” stocks.
On this scale it looks quite normal, so let’s look at just the difference between the two.
Across the entire period, Stakeholder yield has delivered a return of 14.5%, and Shareholder yield a return of 12.4%. This means that investors have been rewarded more by buying stocks which are both paying back shareholders AND reducing their debt. But that script has flipped somewhat after the global financial crisis, arguably because interest rates have been so low. Companies taking advantage of cheap money in recent years seem to have had an edge.
So, here is what we know:
- Buybacks, in dollar terms, are high and have historically peaked at inopportune times, but the raw dollars don’t matter as much as the yield, which remains much lower than the late 2007/early 2008 high.
- Buybacks are very different across time and across sectors, so painting them with just a market-wide brush isn’t fair.
- The level of conviction in a buyback program (measured as a percent of shares repurchased) has a relationship to relative cheapness: high conviction buyback programs have been conducted at solid prices on average through the last few decades.
- Buying companies with the highest buyback/shareholder yields has been a great investing strategy.
- For most of our history, you’d also want to favor companies reducing debt, but less so during the recent low interest rate environment.
What else would you like to know about buybacks?