Buybacks Aren't Doing Much For Shareholders Right Now

"If everyone is doing (buybacks), there must be something wrong with them." 

- Henry Singleton, former Teledyne CEO (profiled in The Outsiders)

With the exception of 2009, gross buybacks have outpaced dividends paid by U.S. companies each year since 1997. As such, it's absolutely critical that investors -- even dividend investors -- take buybacks into consideration when evaluating companies.

But as Michael Mauboussin points out in a recent study on capital allocation, unlike dividends, which treat all shareholders equally:

In a buyback, selling shareholders benefit at the expense of ongoing shareholders if the stock is overvalued, and ongoing shareholders benefit at the expense of selling shareholders if the stock is undervalued. All shareholders are treated uniformly only if the stock price is at fair value.

In other words, when a company repurchases its shares at a discount to fair value, it's a good use of shareholder capital and ongoing shareholders make out quite well. However, relatively few management teams consistently buyback stock at opportunistic prices.

Indeed, the number of S&P 500 companies repurchasing shares and the amount spent on buybacks tends to follow the market.

While there are undoubtedly some companies making smart and opportunistic buyback decisions today, when the majority of companies are also buying back stock, it's not likely that companies on average are adding much long-term shareholder value with share repurchases.

Jim Chanos, in an interview with Barry Ritholtz, echoed these sentiments:

And when corporations embarked on massive buybacks across all industries and all companies, in effect these CEOs are buying the stock market. So what they’re telling you then, is unequivocally that they think that either they’re happy to earn the stock market rate of return or maybe something hopefully better. Or their rate of return on the margin of any new capital project is much much lower, in fact half or less of what is stated. And that does not bode well for the future of profits, or for the quality of earnings reported as current profits.

Any investor can earn the market rate of return on their own using low-cost index funds. We certainly don't need companies doing it on our behalf. If companies can't find projects (including their own stocks) that generate long-term value, that cash should be returned to shareholders via dividends. Let the shareholders decide how to reinvest the cash as they see fit.

Let me know what you think in the comments below or on Twitter @toddwenning

Stay patient, stay focused.

Best,

Todd

This is the Opposite of Real Investing

Innovation in finance is designed largely to benefit those who create the complex new products, rather than those who own them. - Jack Bogle 

Earlier this week, I came across an article about "math nerds taking over Wall Street" and thought it must have been republished from 2006 when quantitative strategies were in their heyday. 

Nope. A few years after the financial crisis broke their old can't-miss algorithims, the quants have returned with a new set of proprietary trading formulas that will work until they don't anymore. 

No one ever said Wall Street had a long memory. 

The article highlights a quantitative software program that "uses historical data and analysis to predict price movements in various assets." 

This line made me think of Buffett's commentary in the 2008 Berkshire letter:

Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas. (my emphasis)

I don't mean to come down too hard on the quants -- they're clearly bright people and there's apparently demand for what they're doing, but their approach is the complete opposite of what we should be trying to do as investors.

Seeking patterns where none exist. (Pi)

Any time you would spend seeking patterns in the newspaper quotes page or developing automatic trading formulas would be much better spent pursuing another type of formula, like the one Buffett outlined in the 1994 Berkshire letter:

We believe that our formula - the purchase at sensible prices of businesses that have good underlying economics and are run by honest and able people - is certain to produce reasonable success. 

This simple formula isn't easy to implement, of course, but it beats using a complex formula that is easy to implement.

What do you think? Let me know on Twitter @toddwenning.

What I've been reading this week:

• The 12 rules of successful investing according to John Lee -- Monevator
• How earnings reports reshape narratives -- Aswath Damodaran
• Masters in Business: Michael Mauboussin (podcast) -- Barry Ritholz
• The best time to invest (video) -- Loring Ward
• Peter Lynch on stock market losses -- A Wealth of Common Sense
• Buy a high yield portfolio and hold forever -- Total Return Investor

Cartoon of the week:

Stay patient, stay focused.

Best,

Todd
@toddwenning