What’s Behind the Buyback Surge?

Does the rise in share repurchases reflect optimism about the future, or a lack of alternatives?

“I think [a buyback has] become the easy way out,” says Gregory Milano, CEO of Fortuna Advisors, a value-based strategy adviser. “A company can get earnings per share accretion with certainty, whereas if they invest in R&D, there is a lot less certainty to whether it will pay off.” In an analysis of buybacks over a five-year period ending in 2008, Fortuna found that companies that put more money into buybacks had lower total shareholder returns (dividends plus capital gains).

That said, if a company has really run out of ideas for deploying capital, or isn’t in a growth business, or can’t cover its cost of capital, a buyback can make sense. Still, many companies would be better served by putting money back into the business, argues Milano.

How big a pop issuers are going to get from buyback programs is another question. As of Tuesday, the share prices of the buyback companies cited above, except for Amazon.com, were within dollars or cents of their 52-week highs. The S&P 500 Index is up 42% from exactly one year ago, and its collective P/E ratio is 22.9%. All this suggests that it could be difficult for buybacks to move stocks much higher.

Taking into account only share price, “six to nine months ago would have been a better time to do [a buyback], but companies had zero confidence in their cash flows then,” says Mallette. Indeed, companies tend to buy back a lot more stock when their share prices are high than when they are low, he says, evidenced by the half a trillion dollars in shares companies bought back in 2007, when markets peaked. “It’s just like M&A: when we feel good about the world, we’re willing to spend money,” says Milano.

Still, companies don’t need pinpoint timing when announcing a stock buyback, since programs usually involve repurchasing stock over a period of one or two years, or even longer. More important than timing is to get shareholders to understand and buy into the thought process behind a buyback, says Mallette. “It’s important for a company’s financial strategy to be judicious,” he says. “If you do it right and consistently, the market will understand that. That buys you more value.”




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