Some market analyst contend stock buybacks do increase shareholder value. In a recent article in Kiplinger Personal Finance Magazine the author notes,
"The obvious reason is that when companies buy back their stock, they reduce the shares outstanding and increase earnings per share. What's less obvious is that companies typically buy back their shares at advantageous times; they know things that you or I may not. They're the ultimate insiders."
Certainly, over the long run, it has been proven that buybacks increase shareholder value through stock appreciation. However, are there differences today that might suggest buybacks are not necessarily shareholder friendly? As Matt Hougan at Seeking Alpha notes,
"In the good old days, companies did buybacks mostly in extraordinary circumstances, like when the stock fell excessively in reaction to relatively minor news. Now, however, buybacks are almost a line item in corporate budgets. X dollars for salaries, Y dollars for office supplies and Z dollars for corporate buybacks.
And that’s bad news for shareholders. Why? For one, buybacks are used to cover up costly options schemes that would otherwise dilute the company’s stock. It’s a neat trick to report profits and then use those profits to cover the real expense of an options program."
Not too surprisingly, there is an exchange traded fund that invests in companies that buy back their own stock. The ETF is the Powershares Buyback Achievers Index (PKW). This ETF has an inception date of December 20, 2006. The Powershares literature does show hypothetical returns going back to February 29, 1996. Over this longer time period, buyback companies have outperformed the S&P 500 Index as noted in the chart below.
(click on chart for larger image)
Since inception of the Powershares buyback index though, the index has underperformed the S& 500 Index.
(click on chart for larger image)
As Matt Hougan also notes,
...buybacks favor management over current shareholders. Corporations have two choices on how to return money to shareholders. They can pay it out as dividends to current shareholders, or they can buy back stock. The problem with buybacks is that they raise the value of both existing shares and shares that have yet to be issued, aka options. Buying back stock today increases the value of the options that executives will cash in tomorrow. And faced with the option of choosing buybacks vs. dividends, not surprisingly, most corporate officers are choosing buybacks.
In the end, an investor must do their homework before assuming buybacks will increase shareholder value through stock price appreciation. The options factor is a larger issue today than it was in the mid to late 1990s when buybacks seemed to be a pretty good indicator of positive future stock price performance.
Barry Rehfeld of the International Herald Tribune noted in an article late last year,
A related post from this site: The Out of Balance Balance Sheet: A Hidden Treasure Trove or Fools Gold
"On a basic level, a buyback can make a stock look attractive by giving an immediate boost to earnings per share, simply by spreading profits over fewer shares. If a share is more valuable, it stands to reason that its price on the open market should be bid up — and very often it is.
Still, hold the rush. Investors who randomly sweep up shares in companies that are buying back stock with the goal of beating the market are likely to be disappointed. According to a recent study of the S&P 500 by Birinyi Associates, a research firm in Westport, Connecticut, companies that bought back stock outperformed those that did not by a mere percentage point over the period from 2000 to 2005.
Zero in on the right stocks, though, and the gains can be significant."
Buying Into Stock Buybacks
Kiplinger Personal Finance Magazine
By: Anne Kates Smith
Buybacks: A Wolf In Sheep's Clothing
By: Matthew Hougan
October 11, 2007
Entry Level: Buying into buybacks? Do your homework
International Herald Tribune
By: Barry Rehfeld
December 15, 2006