Sunday, January 29, 2012

Stock Buybacks Do Not Benefit Future Stock Performance

In a recent research report by Thomson Reuters they note that a company's stock buyback activity generally does not add value subsequent to the buyback. A reason cited is the fact companies generally have more cash on hand in good economic environments and this tends to be after the stock price has already reflected a more positive operating environment. The report concluded:
"...most companies in the S&P 500 index have not been successful in adding value through stock buybacks in the time frames we observed. The positive correlation between buyback activity and price suggests a combination of poor market timing as well as policies that increase repurchases when firms have more free cash flow. This may be partially explained by the need for officers of public companies to make some use of the cash on hand, including keeping less of it due to the possibility of being taken over. The negative correlation between repurchases and forward returns shows that most buybacks did not pay off within the year after purchase."
Even for the market (S&P 500 Index) overall, the increased buyback activity occurs at ever increasing price levels.

From The Blog of HORAN Capital Advisors

One interesting aspect of the buyback activity at this point in time is it does seem to be at a sufficient level that it makes up for the lack of investor fund flows into equity mutual funds. As the below chart notes, cumulative outflows in equity mutual funds is running at a little over $400 billion dollars since 2006. Buybacks over that same time period total approximately $2.1 trillion through the 3rd quarter of 2011 as reported by Standard & Poor's (PDF).

From The Blog of HORAN Capital Advisors

A few companies were highlighted in the Thomson report as having timed their buybacks successfully. One example is St. Jude Medical (STJ). As the below chart shows, the company tended to successfully execute its buyback on dips in the company's stock price.

From The Blog of HORAN Capital Advisors


On the other hand, Exxon Mobil's (XOM) buyback timing seems to occur after the company's stock price has rallied.

From The Blog of HORAN Capital Advisors

For investors then, buybacks tend not to be a good predictor of future stock price performance. We have written several posts in the past about some of the pitfalls in company stock buyback programs. Ideally, investors should focus on a company's dividend practices. When a company increases its dividend, it is making a long term commitment of its future cash flow; hence, a more significant statement about future earnings prospects.

Disclosure: Long XOM and no position in STJ


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