The Boom In Buybacks

February 28, 2014

the importance

S&P 500 companies spent more cash to buy back their stock than to pay dividends in the 2013 third quarter. Unlike dividends, buybacks are irregular, unpredictable and only return cash to those shareholders who sell their stock and reduce or eliminate their position in the company. The performance of the S&P 500 Buyback Index compared with the S&P 500 shows that companies with a past history of buybacks tended to outperform since 2003. Some investment websites and blogs tout buybacks as signals of future performance, while others argue the management’s motivation is simply to pump up earnings per share by reducing the number of shares. However, the reasons behind buybacks are more complex and do explain the performance of the buyback index relative to the S&P 500.

Figure 1 compares the performance of the S&P 500 Buyback Index and the equal-weighted version of the S&P 500 from the start of 1995 through the end of 2013. The S&P 500 Buyback Index consists of the 100 stocks in the S&P 500 with the highest buyback yields—the highest ratio of buybacks in the trailing 12 months to market value at the start of the period. The index is equally weighted; therefore, the equally weighted version of the S&P 500 is the appropriate benchmark for comparison purposes. The S&P 500 Buyback Index was launched on Nov. 29, 2012, and therefore data prior to that date are backtested.

The Boom Buy Backs

The Boom Buy Backs

Buybacks are very different from dividends; maybe the only thing they have in common is the distribution of corporate cash. Investors prize dividends and dividend-paying companies for consistency and predictability. Buybacks offer management some flexibility: Buyback programs may be announced in advance but are often modified, reduced or expanded before completion. Unlike a dividend cut, companies are rarely penalized in the market for revising buyback programs.



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