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Stock Buybacks Exceed Dividends
Old 06-25-2008, 07:30 AM   #1
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Stock Buybacks Exceed Dividends

I read this article yesterday on Bloomberg's site:

Bloomberg.com: Investment Tools

The article looked at some specific stocks, but it was the context statements that really caught my eye. Excerpt:
Companies in the S&P 500 pared buybacks to $113.9 billion in the first quarter from $117.7 billion a year ago, the first drop in four years, according to S&P data...Stock repurchases by S&P 500 companies rose to a record $589 billion last year as the index gained for a fifth year, according to S&P data. Buybacks were more than twice the value of dividends...
The statement that total stock repurchases greatly exceeded total dividends was a surprise. Maybe it shouldn't have been given the long-running trend of companies moving away from dividends...

Many posts here and elsewhere cover the ins and outs of investing in dividend-paying stocks and mutual funds. I'm wondering if forum members could offer opinions and advice on an alternative stock and mutual fund picking strategy that focuses on companies that are choosing to return a greater portion of their profits to investors via stock buybacks.

For an investor in the accumulation phase, focused on total return in tax-sheltered accounts, it would appear that a sustained stock buyback program would be a good, albeit incomplete, indicator of healthy prospects for a stock.

If so, how should I research this strategy in more detail?

In the final analysis, is a stock buyback program likely to be anything more than a supporting indicator?
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Old 06-25-2008, 08:37 AM   #2
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Buybacks can be tricky. Often little or nothing is really being returned to investors, and issued shares outstanding are being shrunk little if at all. It is just a revolving door, the corporation buys in its stick, then passes it out to employees and especially officers via options or other forms of "incentive compensation". So rather than cash being returned to investors, ownership of the company is being transferred from outside stockholders to insiders.

OTOH, the companies that are actually shrinking their stock count can be interesting. I have stock in an otherwise questionable investment just because it is well run, and it is dramatically shrinking its equity cpaitalization. And they buy more when the stock is down, maybe float some new equity when it is way up, if they have good use for the money.

Another thing about "buybacks" is that too often the same company that buys back its stock at the highs (could it be so that executives get a bigger score when they exercise options?) will later be forced into equity markets to raise cash when business is bad.

Ha
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Old 06-25-2008, 08:58 AM   #3
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It always strikes me as strange when a company announces a share buyback when the stock price and PE are both high by historical standards. I never seem to see buybacks announced when the stock is cheap. It almost seems like the companies have a philosophy of buy high, sell low. How long would we survive investing that way?

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Old 06-25-2008, 09:36 AM   #4
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I seem to recall reading that the buybacks gererally pale in comparison to the option grants, as Ha mentioned.
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Old 06-25-2008, 11:25 AM   #5
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The issue with dividends is that once companies give one out- even $.01 per year or per quarter- it is tough to take away. Taking away the dividend may hurt the price more than offering it in the first place helped.

This trend (more buybacks, less dividends) was also prevalent when I started investing in 1997. In 2000 my dividend fund performed much better than the rest of my portfolio.

I think the way to leverage this is to invest in the funds which follow dividend investing. PRFDX (T Rowe Equity Income) is what I use, Vanguard Windsor and Windsor II are other good choices with similar strategies.

I am not aware of a fund which targets companies buying back shares, but I bet if you looked at fundalarm, that board might be able to help.

Being in the accumulation phase, I would actually argue you want the dividend fund, not the share buyback fund.
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Old 06-25-2008, 03:45 PM   #6
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Quote:
Originally Posted by grumpy View Post
It always strikes me as strange when a company announces a share buyback when the stock price and PE are both high by historical standards. I never seem to see buybacks announced when the stock is cheap. It almost seems like the companies have a philosophy of buy high, sell low. How long would we survive investing that way?
I seem to have noticed that also, but I've never studied it, could just be the ones I notice.

There must be a study out there...

-ERD50
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Old 06-25-2008, 06:40 PM   #7
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Quote:
Originally Posted by ERD50 View Post
Quote:
Originally Posted by grumpy View Post
It always strikes me as strange when a company announces a share buyback when the stock price and PE are both high by historical standards. I never seem to see buybacks announced when the stock is cheap. It almost seems like the companies have a philosophy of buy high, sell low. How long would we survive investing that way?
I seem to have noticed that also, but I've never studied it, could just be the ones I notice.

There must be a study out there...

-ERD50
I think the logic is the share buybacks decrease shares, so the price (demand) of existing shares increases (regardless of present valuation).

In addition if a company announces a buyback today, they will usually state the shares will be bought back over a 2 year period or similar- this way it does not spike volume on any day in particular and company can buy back when price is cheaper.
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Old 06-25-2008, 08:15 PM   #8
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All very interesting...thanks for the responses.

Quote:
Originally Posted by ERD50 View Post
There must be a study out there...
The Failure of Stock Buybacks
[by S&P] "Conventional wisdom holds that (1) stock prices go up as a result of buybacks, (2) more buybacks are better than fewer buybacks, and (3) announced share buybacks actually reduce the number of outstanding shares significantly.

Based on a study of buybacks conducted by S&P's Equity Research Services of the 18 months ended June 30, 2007, we believe that all three points were unsupported by the data during that period.

While analysis over a longer time frame may be warranted, we contend that shareholders need to more closely question buyback activities undertaken by corporations rather than applauding these decisions without closer examination."
SSRN-Shareholder/Option Holder Profit Splits on Stock Buybacks as a Measure of Liability (#10) - Summary of 11 Case Studies (AMAT, CSCO, CY, INTC, NSM, NVDA, ORCL, SNPS, SYMC, TXN, XLNX) by Michael Gumport

"...if a company issues options equal to 25% of outstanding shares, then, in theory, shareholders/option holders "contract" to split future stock profits 80/20. Dividends, however, escape the contract and are paid exclusively to shareholders. To "solve" the dividend "dilemma", corporations favor buybacks. Yet, buybacks tilt returns, too, but in favor of option holders. Measurement of the degree to which buybacks "break" the contract by delivering benefits skewed to option holders is one quantitative gauge of potential liability.

In 11 case studies of companies that conduct $90.6 billion of buybacks in 2004-2007, the average company has an option plan that suggests shareholders and option holders will split future equity value growth 85/15 in favor of shareholders. However, the split from buyback benefits actually is 43/57 in favor of option holders. The 42 point "excess return" to option holders on average amounts to $1.013 billion per company. It is equivalent to a cost per share of 2.2% borne by shareholders. The capitalized cost to shareholders of the "excess return" to option holders from buybacks equals 13.7% of the average company's current stock price and is akin to a dividend paid by stockholders to option holders. Whether the skewed division of buyback profits is fair and reasonable depends upon the particular circumstances of each company."
My takeaways:
  1. A buyback program by itself don't say much.
  2. A net reduction in the number of outstanding shares over time is a better (but far from foolproof) indicator of improving fundamentals (I.e. if one believes EPS going up will drive a stock's price up, make sure the 'S' is really going down)
  3. Be a bit wary of a buyback program when there are large (or increasing) numbers of employee option shares lurking in the background
  4. #3 is another reason I should stick to index funds
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Old 06-25-2008, 08:42 PM   #9
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Thanks Htown_Harry, I love it when my gut feeling gets backed up by real data! - ERD50
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Old 06-26-2008, 01:11 PM   #10
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Hmmm - I've never trusted the bastards since 1948, getting off the school bus and seeing the Norwegian widow waiting by the mailboxes for her dividend checks.

And that's before 1957 - when I first got some idea what is a stock or mutual fund.

Dividends are kinda like cash which is almost as good as real money - to paraphrase Yogi.

heh heh heh - .
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