What Investors Should Look for in a Record Buyback Environment

Why Bigger is Better for Stock Buybacks

Michael Schoonover, COO & Portfolio Manager
Michael Schoonover is Chief Operating Officer of Catalyst Capital Advisors LLC and Rational Advisors, Inc. and Portfolio Manager of a share buyback strategy fund at Catalyst Funds. He began his association with Catalyst in 2011 as a research consultant supporting the implementation and back testing of quantitative strategies. In March 2013, he became a senior analyst at Catalyst to provide investment research for several mutual funds. From 2005-2011, he served in various technical and scientific management roles with the Perrigo Company. Mr. Schoonover has an MBA with high distinction from the University of Michigan Ross School of Business and a BS from the University of Michigan.

With more than 900 U.S. companies announcing $1.08 trillion in buyback authorizations, 2018 was a record-setting year for buybacks. This year is also off to a similarly strong start with more than 300 companies authorizing more than $360 billion in buybacks as of April 30. With so many buybacks to examine in this record-setting environment, where should an investor start?

We submitted a byline to U.S. News & World Report’s Smarter Investor arguing why bigger is better when it comes to buybacks. In this blog, we expand upon that summary to highlight the importance of looking at relative buyback size when trying to find the most compelling investment options.

When it comes to larger buybacks, it’s the relative size of the buyback that matters and not the absolute size. For example, a $1 billion buyback authorization from a company with a $100 billion market cap, or 1% of outstanding shares, isn’t nearly as meaningful as a $250 million buyback for a $1 billion market cap company, or 25% of outstanding shares. Even though the $1 billion buyback is larger on an absolute basis, the $250 million buyback at 25% of outstanding shares exhibits characteristics that have historically resulted in better shareholder returns.

Historical analysis of buyback activity by EqutiyCompass Strategies, which examines 10,070 unique buyback announcements from December 1995 to April 2010, demonstrates that larger relative buybacks yielded higher relative returns.

When trying to understand why this is the case, one point to consider is that large share repurchase authorizations provide companies the potential to influence their share price. U.S. companies are governed by rule 10b-18 when it comes to buying back or repurchasing their own stock. There are some conditions that specify what a company can do, including a repurchase limit of up to 25% of the average daily trading volume. This large trading volume provides companies with the opportunity to influence their share price. Companies with large buyback announcements can continue to purchase stock at a high percentage of trading volume for up to several months, providing a catalyst to drive up the price of the stock and potentially squeeze short sellers along the way.

There are several companies with recent buyback announcements that showcase the impact a large buyback can have on the stock’s performance.

RH, formerly Restoration Hardware (ticker: RH), with three separate buyback announcements, is a great example. The first, announced at market close on Feb. 23, 2017, was for $300 million, or 29% of its outstanding shares. At the time of the announcement, the stock was down from over $105 in November 2015 to $25.19. Gary Friedman, Chairman and CEO, commented, “We believe our shares are currently undervalued and based on the strength of our balance sheet, coupled with our long-term outlook, an opportunity exists to create value for our shareholders, while continuing to invest in our key value-driving strategies – the transformation of our real estate and expansion of our product offering.”

The second buyback was announced at the close on May 4, 2017, following completion of the previous $300 million buyback. This buyback was for $700 million (38% of outstanding shares) and completed in the second quarter of 2017. “We continue to believe our shares are undervalued and based on the strength of our balance sheet, coupled with the current and long-term outlook for our business, an opportunity exists to create value for our long-term shareholders,” said Friedman.

From the time RH announced its first buyback to announcing its second, the stock returned 105.9% versus 1.4% for the S&P 500 TR index. In the year following the second buyback announcement, RH returned 94.5% versus 13.7% for the S&P 500 TR index.

Exhibit 1: RH relative performance vs S&P 500 TR Index between first & second buyback announcement

Exhibit 2: RH relative performance vs S&P 500 TR Index in the year following the second buyback announcement

The company announced another buyback on Oct. 11, 2018, for $700 million, which was 29% of its outstanding shares. Of that, RH repurchased $145 million in the third quarter 2018 and another $105 million in the fourth quarter. This was at a slower pace than previous repurchases. While RH was up 45% versus the S&P 500 TR Index’s 1.5%, as of March 1, 2019, RH is up only 1.5% versus the S&P 500 TR index’s gain of 5.9% as of May 2. This drop at the end of March followed analysts’ concerns about the impact from tax law changes on housing and a softening high-end housing market. With this dip, RH may see a buying opportunity with significant buyback potential left.

There are other companies with large, proportional buyback announcements that showed similar results. Crocs (CROX) announced a buyback authorization increase to $500 million (29% of outstanding shares) on Feb. 28, 2018. This buyback was announced after shares declined on recent results/outlook. Some research firms on Wall Street saw it as a buying opportunity, as did Crocs. In the year following the buyback announcement, CROX returned 102.7% versus the S&P 500 TR index return of 3.8%.

Exhibit 3: CROX relative performance vs S&P 500 TR Index in the year following large buyback announcement

Sonic Corp. announced a $500 million buyback (39% of outstanding shares) on June 7, 2018. “The Board’s decision to increase and extend the share repurchase authorization reflects our confidence in the company’s ability to leverage our asset-light model to improve results and drive long-term growth and value creation,” said J. Clifford Hudson, CEO of Sonic. “We believe that Sonic represents a compelling investment opportunity and remain committed to returning capital to shareholders through share repurchases and our ongoing dividend program while continuing to invest in the business.” In December 2018, the company was acquired by Inspire Brands. In the time between buyback announcement and the acquisition, Sonic returned 64.2% versus the S&P 500 TR loss of 1.8%.

Exhibit 4: SONC relative performance vs S&P 500 TR Index between buyback announcement and acquisition

Sinclair Broadcast Group (SBGI) announced a $1 billion buyback (35% of outstanding shares) on Aug. 9, 2018. Chris Ripley, CEO, states, “It is unfortunate that Tribune Media Company terminated our Merger Agreement. Nonetheless, we strongly believe in the long-term outlook of our Company and disagree with the market’s current discounted view on our share price. The $1 billion authorization does not use our future cash flow generation, but simply the excess cash currently on our balance sheet.” From that point until May 29, 2019, SBGI returned 99.5% versus -0.8% for the S&P 500 TR index.

Exhibit 5: SBGI relative performance vs S&P 500 TR Index between buyback announcement and 5/29/19

On Jan. 23, Lam Research Corp. (LRCX) announced a buyback for $5 billion, which represents 23% of its outstanding shares. This was announced in conjunction with earnings that beat the highest estimate. LRCX has since returned 28.3% versus 6.3% for the S&P 500 TR index as of 5/29/2019.

Exhibit 6: LRCX relative performance vs S&P 500 TR Index between buyback announcement and 5/29/19

All of these companies highlight the impact of large, proportional buybacks on their future stock price. Large buybacks, where management has conviction, can be a powerful tool for investors who are evaluating opportunities in the market. The size of the buyback, as it compares to the company’s outstanding shares, is the number to look for.