Monday, December 27, 2010

Buybacks: In Style At The Wrong Time

Compared to dividends, buybacks provide a more tax efficient method of returning cash to shareholders. But any tax benefits may be more than reversed by the exceedingly poor prices at which corporations buy back their own shares.

Previously, we have seen anecdotal evidence of this, as we examined the recent buyback records of Wal-Mart, The Home Depot, Best Buy, Target and Lowe's. The higher the stock price, the more money these firms would pump into buying back shares, which was the exact opposite of what they should have been doing. For a more recent example, look no further than Netflix (NFLX), which trades at a P/E of 70 and yet continues to buy back shares.

Anecdotal evidence can be misleading, however, and therefore it makes more sense to consider the aggregate market as a whole. The following chart depicts the level of buybacks for the S&P 500 over the last four years:

Note how well this correlates with the overall market. As the market peaked in 2007, firms were furiously buying up shares. As the market fell to its lowest level in March of 2009, companies were too scared to buy back shares. Yet, this is exactly when many companies (those not in debt trouble) should have been active in the market.

Today, companies in the aggregate appear to have regained their appetites for buybacks. But prices have recovered as well, so that even though buyback funds are almost four times higher than they were in the second quarter of 2009, they pack about 40% less punch per dollar. Seeing as how the top tax rate on corporate dividends in the US is 15%, perhaps investors in the aggregate would be better off with dividends over buybacks despite the tax hit.

source: Standard and Poor's


StockPup said...

Saj, you are making an excellent and important point on poor timing of most share buybacks. At the same time, I have to defend the long-term records of WMT and LOW. While their short-term timing could have been better, in the long run they are making buybacks during periods of historically low stock prices (relative to book value). I just wrote a quick blog post to address this:

Albie Cilliers said...

Hi Saj

I don't trust companies buying back shares at high valuations. I tend to look for management supporting the share price to keep their stock options high in the money. I rather look for honest management who has very good capital allocation records who buy back shares when it makes sense to do so, and add value rather than destroys value.

Only my opinion, but the sea is big enough to fish for those worthy of my capital.

the_obtuse_investor said...

Hi Saj,
I enjoyed this post of yours. Although I agree with what you said in principle, I have posted a counter example on my blog.

The counter example doesn't invalidate your claim, but I wanted to point out there are exceptions to rule out there. And it pays to find them.


Anonymous said...


Thanks for your article.

I think that you are tracking share purchases rather than float shrinkage.

This is a bit misleading because a fair amount of stock buy-backs is designed to offset the exercise of stock options. Since more people exercise options in a rising market than in a falling market this will tend to distort the reported amount of money that companies are spending on buybacks.