Buybacks: Stop Believing
Does anyone remember how popular stock splits were in the Internet bubble? During that bubble, news of a split was a reliable indicator to buy MORE stock. It indicated the company was expecting growth and wanted the stock price to be low enough that people could buy it. That worked until it didn’t. The bubble popped and splits never regained their popularity.
Another technique has risen in its stead, the stock buyback. News that a company is going to buy back some of its stock will almost invariably send returns higher. The narrative is that the company wants to invest in itself, that it thinks its stock price is undervalued and is willing to reinvest its own capital or even borrow money cheaply to buy company equity.
The classic successful example of buying back stock, which is trotted out as justification at business schools, is Teledyne, which was managed by Henry Singleton. Singleton bought the stock back in the 1970s when it was low and re-issued the shares when it was high. Warren Buffett sang Singleton’s praises multiple times and indeed Singleton did make his investors a fortune.
As a side note, as I researched buybacks, I found that prior to 1982, regulators actually frowned upon buybacks because they viewed them as a quasi form of insider trading. After President Reagan pushed deregulation in the early 1980s, this view loosened and opened the doors to more buybacks.
Back to the present. Apple is the current poster child for buybacks. Carl Icahn, the famous corporate raider now “activist” investor, pushed the company to buy back stock in 2013. Buffett joined the party in 2016 with an investment and then justified corporate buybacks (again) in his 2018 shareholders meeting. Apple, sitting on a mountain of cash actually decided to borrow money to buy its own stock because rates were so low and it had such a strong balance sheet. Like Teledyne, this has paid off tremendously for Apple investors. It should be noted that tax law encourages this; interest can be deducted from your taxes and capital gains can be deferred and compounded until the stock is sold.
Given these two examples, it seems pretty obvious why companies would want to buy back their own stock, and, in fact, companies have spent multiple TRILLIONs over the last two decades doing so. It is an easy way to boost earnings per share which, in turn, should boost the stock price. Since almost every executive is compensated with stock options, taking action to increase the share price through a little financial engineering is almost inevitable. If you don’t own the stock, this has shades of insider manipulation, but let’s ignore that messy ethical detail for now.
My question is, do corporate buybacks ACTUALLY increase long-term stock returns?
To answer this, I pulled some data over the last five years; stock prices of all the S&P 500 companies and the changes in their total issued equity. Companies that bought back some percentage of their shares should see some positive stock price returns and, conversely, those that issue shares should see their stock prices fall. This is the raw logic that CEO’s are using to influence the value of their compensation when they buy back stock either with cash on their balance sheet or money they have borrowed.
I regressed the percent change in equity (positive change for shares bought back) vs stock price returns, both over the last 5 years. I expected to find some positive correlation. The chart is below and you can judge for yourself.
It turns out, with this simple regression, it is reasonably easy to see that buybacks do NOT correlate well with long-term stock returns; there doesn’t seem to be even a small positive relationship, the R2 is essentially 0. If we aggressively prune outliers and eliminate 20% of the data we can get an R2 as high as ... 11%.
So it seems the vast majority of CEOs don’t have much “edge” when it comes to investing in their own stock; they should probably stick to their knitting and focus on improving their product, their execution, or their operations if they want to increase the value of their firm.
My conclusion: buybacks don’t seem to be a reliable way to increase the intrinsic value of a company and shouldn’t be a major consideration when investing in a company for the long-term.