Fall in buy-backs hint at an optimistic business environment or just the end of another bubble?
Q2 2014 witnessed a decline in the buy-back binge when for the first time since Q3 2012 buy-back volume recorded a decline. Cash flushed corporates have recorded outflows of $539.3 Billion in share buybacks in the past 12 months and $338.3 Billion alone in the first six months of 2014 – the highest volume since the financial crisis.
Conventionally, blue chip companies have been associated with share buy-backs, however the recent past witnessed buy-backs being championed by the consumer discretionary (34.5% Year on Year growth) and financial sectors (27.5% Year on Year growth) with the IT sector contracting (19.3% Year over Year). As far as the financial sector is concerned for a large section buy-back activity is linked to stress tests (CCAR) and catching up with pre-crisis share valuations and dividends.
Traditionally buy-backs are seen a tool to return value to shareholders in the form of capital - motivated by the lack of better investment opportunities. Investment in long term assets at the face of weak economic conditions translates into capacity build up often acts against the interest of shareholders if faced by economic downturns.
An interesting example to cite here would be the case of home improvement retailer The Home Depot (THD). In the late 1990s and mid 2000s the retailer invested excess cash holdings in infrastructure development to meet the demands from the then flourishing housing market. The crisis hit in 2008 and the retailer till date is yet to utilize full capacity.
Thus, returning cash to investors is often the prudent move when faced with uncertain macroeconomic conditions coupled by weak expected returns on future investments.
On the face value it seems to be a legit business proposition however critics to the buy-back policy highlight that unlike dividends, buy-backs don’t treat all shareholders identically, and the company creates value for those who are willing to sell their shares at the cost of those who are not.
The welfare loss is heightened when firms motivate buybacks of over-valued shares. More often than not buy backs are synchronous to excess cash holdings which in turn is aligned to positive expectations and thus timed when valuation is on the rise.
Buy-backs by reducing the number of outstanding shares in the market inflate the earnings per share metric. This effect is magnified when firms finance share buy-backs through debt. The fact that the FED signals commitment to a low interest rate environment coupled by the fact that interest expense is tax deductible as opposed to dividend pay outs, makes share buy-back a hard to resist temptation. The temptation becomes even sweeter and harder to resist when compensation plans of executives are tied to share prices or even EPS.
Analysts for the past of couple quarters have been throwing caution by highlighting growth trajectory of buyback volumes. Likewise the graph below depicts the growth path of share buy-backs which preceded the crisis.
The image has been sourced from Share buy-back report published by FACTSET. For more details click here.
Despite the caveats underlying stock repurchases, with the economy showing modest signs recovery, it might be the right time to transition cash from buy-backs to operating activity. The current decline seems to indicate a change in direction as far as cash management policies are concerned - perhaps indicative of stronger growth expectations.
So what are your thoughts?
The content for the blog has been sourced using:
Winter Quarterly Commentary - Knightsbridge Asset Management , Buy-Back Quarterly FACTSET, Share buy-backs The repurchase revolution , Share buy-backs Corporate co***ne , The Profit Motive , Stock Buybacks: Breaking the Habit
Thanks for the article, very interesting.
Repurchases are a benefit for all shareholders. Those willing to sell realize a higher price. Those not willing to sell benefit in the form of a greater percentage ownership in the company.
However, repurchases can also destroy wealth just as easily. Companies buying shares that are overvalued harm existing shareholders to the benefit of those selling the overpriced shares. In other words: It's all about timing.
The fact that buybacks are so popular now is precisely why I'm skeptical of them. I want companies I own buying back shares when no one else is. Is Warren Buffett buying back his shares now? Probably not. He's waiting for a correction and pulling the trigger when shares approach book value.
If you see a heard of people all doing the same thing, it's time to start asking questions.
As a shareholder (especially one willing to sell shares back to the company - meaning, if you sell all your shares, you will no longer own part of the company) wouldn't you prefer buybacks to happen before corrections, when shares are overvalued, thus resulting in a higher sale price for you?
Little confused by your comments.
You are absolutely correct. My frame of reference is of an investor or long term shareholder.
Taking on your frame of reference, if I'm a net seller in the short term, I would want the company to buy back as much as possible, regardless of price, jacking the stock up before I sell to the poor sucker who is about to lose his shirt.
Makes sense. I agree that if you're a long-term shareholder you definitely want management to buy back stock when it isn't overvalued.
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