|  David Fried is editor and publisher of The Buyback Letter and BuybackLetter.com, both devoted to finding opportunities among companies that repurchase their own stock. His business and investing experience has helped him develop a unique ability to analyze a company's prospects and develop strategies to take advantage of buyback information. Mr Fried also offers investor advisory and money management services based upon these strategies. Profiting from buybacks Introduction A buyback stock is stock of a company which buys back a significant number of their own shares. For 50 years , buyback stocks have outperformed the market - sometimes spectacularly so. A major study of the U.S. stock market over a 10 year period of time found that in each four year period, value buyback stocks (buyback stocks with high book-to-market ratios) generated returns 45% higher than other stocks, 24% annually vs an annual return of 15% for the average stock. Over a 10-year period this out-performance means that $10,000 invested in the S&P 500 would grow to $40,400 while the same $10,000 invested in buyback value stocks would grow to $79,200, an out-performance of about 388%! -
Buybacks increase the value of your shares. Buybacks benefit stockholders in a number of ways. By decreasing the number of shares outstanding, they increase the purchasing company's earnings per share. As earnings per share increase, the price of the stock generally rises. This increases the value of the shareholders' current holdings without requiring any additional investment, and without the taxes that would be incurred if the company had paid the same money out as dividends . Additionally, buyback companies provide shareholders with a margin of support under their stock by stepping in and buying shares when their price falls . This often causes its shares to rebound faster after a market correction, as there are fewer shares available when demand returns. -
No-one understands a company better than the company itself. When companies buy back their own stocks, it's an enormous vote of confidence in the stock by those who know it best - the company's senior executives. No one else knows more about the firm's financial situation, it's market share, business plans, research and development programs, or new products. Those executives usually keep their plans, tactics, and research behind closed doors. However, a stock buyback tips you off that the stock is primed to go up. -
But buybacks are not that simple. First, not every company that announces a stock buyback actually follows through and executes the buyback as announced. Sometimes the actual number of shares purchased is far fewer than announced - converting a major buyback into a minor, insignificant one you should simply ignore. Other times, a company cancels their stock buyback entirely, often with no public announcement. In such cases, the only way you'll know for certain that a buyback has taken place is by looking at a company's quarterly and annual reports . -
It's important to understand a company's motivation for the buyback. While one company's motivation for repurchasing shares may be to use them for the exercise of stock options, another firm may be repurchasing because it feels its shares are under priced and represent a good investment. In fact, 90 percent of buyback announcements do not disclose the reason or the motive behind the announcement. -
Not all buyback companies are equal - focus on the value stocks. In general, buyback companies outperform companies that do not buy back their own stock. But the overall best performance is seen with buyback companies that have the optimum fundamental ratios. Baskets of stocks with low price-earnings, low price-sales, low price-book ratios and high yields tend to outperform baskets of stocks with high price-earnings, price-sales, and price-book ratios and low yields. When a share repurchase effect is added to the mix this effect is even more pronounced. Academic research shows ('Market underreaction to open market share repurchases' - Ikenberry, Lakonishok and Vermaelen) that buyback stocks outperform accross all valuations. However the biggest outperformance comes from the stocks with the lowest fundamental values. -
Avoid the companies that announce buybacks, but never follow through. Some companies are habitual offenders. They make buyback announcements to signal that they believe their shares are undervalued, but never follow through with their announced plans. -
Some companies buy back stock only if and when their shares are bargain-priced. Sky West Airlines is an example of this type of company. Sky West only repurchases shares when they are close to book value. If the share price rises much beyond that level, the company won't buy its shares back. Companies like Sky West give the opportunity to make good profits over a two or three year period - so long as you can buy shares close to the price at which the company itself purchases them. -
Follow the companies committed to long- term buyback programs as a way of building shareholder value. These companies can be counted on to fulfill their promise when they announce a stock buyback. It's this group that has the most appeal for long-term investors. A prime example is Coca-Cola, perhaps the ultimate buyback company. Since beginning its buyback program in 1984, Coke has repurchased 966 million shares (adjusted for splits ). In their annual report, Coca-Cola states that it has "always viewed its stock as a consistent bargain for long-term holders." During the period from 1984-1996, Coca-Cola's stock buyback has turned 14% annual gains in profitability into 18% annual growth in per-share earnings. -
The corollary to buyback investing is to avoid companies that are issuing additional shares. A study by Loughran and Ritter ('The New Issues Puzzle') found that the average annual return of issuing companies in their sample was 7% a year, compared with a 15% return from a comparable sample of non-issuing companies. The study's conclusion: "Investing in firms issuing stock is hazardous to your wealth." www.buybackletter.com 'Trust the debt analysts. Their financial models for companies are far more rigorous than those of the equity crowd .' ”Thom Calandra |  |
