Stock Repurchases: More Money, More Problems?
The US economic recovery sent earnings per share reported by S&P 500 companies soaring 18% in the third quarter of 2011 over year-earlier levels, with earnings levels setting a fresh high. Along with high net income went higher aggregate free cash flow, leaving companies with excess cash. One possible use of that excess cash is buying back outstanding shares. But have companies who buy back shares done so opportunistically? We found that most don’t (although some do) and we have some noteworthy names to share.
We examined returns on stocks in the S&P 500 in the periods following buybacks and found that repurchases were weakly to moderately negatively correlated with future returns. That signals that this collection of U.S. companies timed their buyback activity poorly,
To identify individual companies that have a record of timing their stock repurchases which add shareholder value, we scrutinized share repurchase, price, and market capitalization data from the Reuters Fundamentals database for the past 10 years for the constituents of the S&P 500 index. Dividing quarterly share repurchases by market capitalization normalizes repurchase activity in a given quarter. By comparing quarterly stock repurchase activity with future stock performance, it is possible to identify companies which have a track record of buying back their shares at a low price – benefitting their shareholders – as well as those companies that have shown poor timing skills.
We removed companies that bought stock in fewer than 5 of the 40 quarters during the period reviewed, thus eliminating the impact of companies without an active stock repurchase policy and improving the statistical significance of the results by guaranteeing at least 5 data points. Using the remaining 380 companies in our sample, we then calculated 3-month, 6-month, and 1-year forward returns. Next, we ran several correlation analyses for each stock, comparing repurchases with price and with each forward performance period.
To identify the companies with the best records of adding value through share repurchases, we used the correlation between repurchases and price to sort the companies. After determining which companies had the most significant negative correlation, we further narrowed the field by choosing companies that had positive correlation between buybacks and future returns. This allowed us to identify companies that bought their stock back when the price was low, but that also made purchases that were followed by periods of higher stock prices.
Results for the five most active companies are summarized in the table below. To find the list of the companies that were the worst for adding value through buybacks and to see the more detailed report, click here.
Buybacks benefitted a company’s share price whether or not they sent signals that resulted in increased prices and regardless of whether the companies were simply buying on price dips to pick up some cheap shares. The general repurchase activity pattern for these companies is that they don’t necessarily buy back shares on a regular basis; rather they opportunistically do so when their stock price drops. This is demonstrated by JC Penney Inc., as shown in the chart below. This company successfully bought back stock following a price decline and then reduced or stopped buying when the share price recovered.
This study suggests that most companies in the S&P 500 index have not successfully added value through stock buybacks in the time frames that we studied. The positive correlation between buyback activity and price means companies repurchased more shares at higher prices and fewer shares at lower prices. This suggests a combination of poor market timing with corporate policies that increase repurchases when firms have more free cash flow available for the purpose. This may be partially explained by the need for officers of public companies to make some use of the cash on hand, including the incentive to keep less on hand lest it prove attractive to a potential acquirer and precipitate a takeover bid. The negative correlation between repurchases and forward returns shows that most buybacks did not pay off within the year after the repurchases. We found that surprisingly few companies repurchased shares at lower prices and had it pay off for shareholders within the following year. However, we were able to identify several firms with a record of strategically repurchasing shares at low prices. We urge investors to thoroughly analyze a company’s share repurchase policy and its track record when considering making an investment.
You can read the full report here.