There have been extensive debates about corporate stock buyback programs. Some critics argue that companies create inequity and do not focus on improving employee benefits, business strategies, and R&D programs. On the other hand, proponents argue that allocating capital to shareholders allows the capital to be reinvested in productive facets. Therefore, advocates believe that buybacks have, in some regards, taken the place of ordinary dividends to return cash to shareholders.
Since the 2018 Tax Cuts and Jobs Act, corporate buybacks have boomed to record highs. However, the upcoming U.S. presidential election and global economic uncertainty driven by the coronavirus pandemic have created headwinds. COVID-19 economic shutdowns nationally and regionally have negatively impacted high exposure industries in the travel, airline, leisure, hospitality, retail, and certain real estate markets. The continued uncertainty resulted in a mass pursuit to preserve cash, increase liquidity, and suspend 2020 guidance. Unfortunately, this pursuit of liquidity resulted in a decrease in continued and new repurchase programs. However, despite the desire for excess liquidity and the recent downdraft of corporate buyback announcements, we still see ample investment opportunity with corporate buybacks at the forefront.
Differentiating a good buyback from a bad one encompasses several interconnected factors. Apple Inc. (AAPL) is a good example of a company doing a corporate buyback for the right reasons. We will discuss below why Apple Inc. is an example of a healthy buyback.
Where is this opportunity, and how do you capitalize on it? (i.e. Why is Apple Inc. a healthy buyback?)
It is important to remember that corporate buybacks are just one component of a complete price driving catalyst. We use many aspects to optimize return and generate attractive risk-adjusted returns using corporate buybacks as the main determinant. However, differentiating a company’s corporate buyback announcement between a fundamentally sound capital allocation decision and a short-term decision to maximize personal gain is imperative for optimizing returns. A good buyback from a bad one encompasses several interconnected factors. Therefore, the main benefit originates from overlaying the buyback announcement with quantitative methods to identify U.S. companies with the most-favorable share buyback announcement. This is accomplished by focusing on the buyback’s size, the frequency of the buyback announcement, the length of time since the announcement, post-announcement price reaction, volatility, liquidity, and trading patterns.
Additionally, it is important to understand the timing of the corporate buyback announcements. We have found that companies that consistently announce repurchase programs have the best track record for the buyback’s proper integrity. The continued frequency minimizes the short-term benefit of companies buying back shares. They do not have a one-time inflated earnings per share (EPS) result caused by a reduction in the shares outstanding. Additionally, internal research has found that the company’s issuing corporate buybacks during times of stress have a higher likelihood of strong fundamentals and compelling balance sheets. Overlaying our company-specific analysis illustrates the company’s buyback integrity. If the company’s integrity remains intact, their returns should beat in line with the advocate’s optimistic argument.
That said, we also find it important to monitor the thematic backdrop of companies announcing buybacks continually. This exposes corporate decisions that allocate their capital inefficiently or inappropriately. In addition to quantitative analysis, a qualitative analysis focusing on economic, sector, and company specific fundamentals supported by technical analysis highlights the underlying opportunities the corporate buyback announcements attempted to illustrate.
As mentioned earlier, a company like Apple Inc. meets all criteria for a healthy corporate buyback program. They have been a consistent announcer; they use buybacks as part of a well-balanced corporate strategy while also remaining one of the most traded, best-performing stocks directly competing with less mature growth companies in a momentum-driven market.
How do companies with corporate buybacks compare to the overall market?
Historically, the information technology, financial, and biotechnology sectors make up the largest announcers for corporate buybacks. This reflects a positive sentiment as these sectors remain sheltered, and some even benefitting from “stay-at-home orders” and a pursuit for a vaccine to combat the coronavirus pandemic. An overweight position in historically strong buyback sectors accompanied by a fundamental overlay (explained above) improves risk-adjusted returns. Even with the continued economic uncertainty, companies with corporate buybacks outperformed the general market since 2009, as seen below:
S&P 500 Buyback Index vs S&P 500 Index
All in all, repatriation, low-interest rates, and undervalued stock prices could help buoy buybacks after coronavirus uncertainty subsides. Even if uncertainty persists, opportunity can be found in corporate buyback announcements by looking past the announcement itself and connecting the integrity of the buyback announcement to the economic, sector, and company-specific fundamentals. It is important to set aside near-term fear jargon and understand that fundamental strength and appropriate company capital allocation are long-term investment decisions. In conclusion, there is value in the corporate buyback environment, but a detailed, strategic approach is pertinent.