Stock Buybacks And Share Prices

January 30, 2015

StockBuybacksOver the past five years, the stock market has experienced a strong and consistent recovery. Major indexes are near record levels. After such a long, sustained bull market, one might ask: “Who are the buyers driving this market?”

The answer, perhaps surprisingly, is that listed companies themselves are among the biggest buyers of stock.1

Where Do Buybacks Come From?
In the process of conducting their business and related activities, companies generate cash; the strategy surrounding the usage of that cash is critical for management and investor success.

Companies can deploy their cash in various ways. One option is to invest in growth opportunities such as research and development, acquisition activity and general capital expenditures. Another is to return the cash to shareholders via a dividend payment or stock buyback. In the post-crisis economic environment, which has offered fits of uncertainty, companies have increasingly chosen to return their cash to shareholders in lieu of investing in riskier growth-related activities.

The Mechanics Of A Buyback Program
A stock buyback (or share repurchase) occurs when a company purchases shares of its own stock, often in the open market, thereby reducing the number of shares outstanding. A company typically uses cash to fund the purchase, though some companies finance the purchase.

The decision on whether to finance the purchase or to use cash is based on numerous factors such as the amount of cash the company has in reserve as well as the state of the lending environment, including current interest rates.

A company starts the buyback process by announcing publicly and to the SEC that it will repurchase shares. The company typically discloses (a) how much stock it intends to repurchase, usually a dollar amount; (b) a timeline for the repurchase, often spanning months or even years; and (c) whether or when it completes any part or all of its repurchase. SEC Rule 10b-18 outlines specific requirements for stock repurchases on the open market including (a) the manner of purchase, which requires that the company purchase from a single broker or dealer on any given day; (b) time and price constraints to ensure fair trading; and (c) volume limitations, prohibiting a company from purchasing more than 25 percent of its average daily volume on any given day.2

Stock buybacks are one of many transactions that a company can execute on its stock. At the same time that it is repurchasing shares, a company may also be issuing new shares via employee equity grants or stock options. It is often the case that share buyback programs are instituted to specifically offset new stock issuance via such grants and/or options. As a result, it is possible for a company to repurchase shares but simultaneously issue even more shares over a stated buyback period.

Buyback Market Trends
Share repurchase plans have been increasing in dollar amount over the past few years. Most recently, buybacks in Q1-2014 grew 50 percent from Q1-2013 and represented the third-largest dollar amount for any quarter since 2005.3 Major U.S. companies that have announced buybacks in 2014 include Apple, which expanded its existing $60 billion buyback to $90 billion,4 and Ford, which announced a $1.8 billion buyback.5 In 2013, S&P 500 companies spent $478 billion on share repurchases, a 24 percent increase over 2012.6

Buybacks are not specific to a certain sector. A January 2014 study by Capital IQ shows that in 2013, each major sector in the Russell 3000 saw between 7 percent and 20 percent of its companies announce a buyback program, resulting in an average of 15 percent across all sectors.7
The top buyback programs by dollar value in Q1-2014 included Apple ($18.5 billion), IBM ($8.3 billion) and Exxon Mobil ($3.9 billion), some of the largest companies in the U.S. The Information Technology sector led the way, accounting for six of the top 10 buyback programs.8

It is important to note that despite very large buybacks by dollar amount, some companies saw only a small decrease in shares outstanding over the previous quarter. This can be the result of two factors. First, the size of the company can mask the effect of a share buyback. Exxon Mobil spent almost $4 billion in share buybacks in Q1-14, but with a market capitalization of more than $400 billion, the result of the buyback was less than a 1 percent decrease in shares outstanding for the quarter. Alternatively, as mentioned before, the issuance of new shares via actions such as secondary offerings or employee equity grants can offset the effect of a buyback.

 

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