Let’s listen to the latest board meeting of Twango, the highly profitable and entirely fictitious company that makes banjos for Latin dance bands. Thanks to an inexplicable surge in banjo-fueled Tango raves – and a major tax cut – Twango is showing record profits this year.
“What are we going to do with all this money?”, asks the CEO. “Should we give the workers a raise?”
“Heck, they got 1% last year,” the treasurer says. “That’s 1% more than everyone else in the country got.” (No, really.)
“Why not raise the dividend?”
“If we do that, we’ll have to pay the increase for eternity,” the treasurer says. “Don’t know if we want to risk that.”
“How about expanding the factory? Increase advertising? Expand to Europe?”
“Whoa, whoa, whoa,” says the Treasurer. “Someone needs to switch to decaf.”
“Ok, then, let’s buy back some stock.”
“Great idea!” says the board.
While this is entirely fiction, it’s not implausible. Companies spent a record high $189.1 billion in stock buybacks in the first quarter, according to Standard & Poor’s. All other things being equal, buybacks should shrink the number of shares outstanding, thereby making remaining shares more valuable. And you can stop a buyback program with a phone call, and no one on Wall Street will say boo. Aside from showing a lack of imagination, what’s wrong with buybacks?
For one thing, an announced buyback program doesn’t really mean anything if the company doesn’t actually buy back stock, and this is an annoyingly common practice. For another thing, many buyback programs are simply a way to pay off executive options. If our Twango CEO exercises his options for 10,000 shares, the company has to get that stock from somewhere, and it’s usually via a buyback program.
Finally, many companies, like many individuals, aren’t particularly good at buying back their own shares. In 2008 and 2009, buyback programs died like a lawn in the middle of a heat wave. Even now, the excellent insiderscore.com has a long list of companies that are buying back shares at high prices.
At least at the moment, buyback strategies haven’t been producing dividends. Invesco BuyBack Achievers ETF (PKW), the largest and oldest buyback ETF is down 3.31% this year, while the Standard & Poor’s 500 stock index is up 2.46%. The ETF buys shares of companies that have reduced their share count by 5% or more in the past 12 months. Top three holdings: Walt Disney, American Express, and Procter & Gamble.
SPDR® S&P 500 Buyback ETF (SPYB) is a newer, smaller entrant into the buyback field. It screens stocks based on the cash value of the actual (not announced) buyback, rather than on the reduction of shares outstanding. The ETF is up 1.58% this year – not better than the S&P 500, but better than the Invesco ETF.
Those looking for companies that seem willing to invest money in the business might check out the Nasdaq US CapEx Achievers Index (CAPEXA). The stocks in the index have increased their capital expenditures for at least three consecutive years. At the moment, there doesn’t seem to be an ETF modeled on the index. Top three holdings: Procter & Gamble, Chevron and Oracle.
Buyback strategies, like most strategies, work best when Wall Street thinks they will. And from 2009 through 2013, buyback strategies worked very well indeed. Lately? Not so much. At least at this point in the economy, it might be best to buy stocks of companies that know how to use their money to grow their business – instead of ones that can’t think of anything better to do with it.