In 2015, BlackRock CEO Larry Fink stirred up a hornet’s nest by suggesting the growing role of share buybacks was a sign of weak corporate strategy. He sent a letter to the CEOs of companies in the S&P 500 and wrote that an emphasis on share repurchases and dividends has led to an under-investment in “innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
In taking the other side of the issue, the Harvard Business Review in its March/April 2018 edition wrote that such views are short-sighted. If buybacks and dividends were such a problem, they suggest, then badly needed internal investments would be getting short shrift. “Overall investment intensity of S&P 500 firms, while quite volatile on a year-to-year basis, has been rising over the past decade, and is now near peak levels not seen since the late 1990s,” the HBR wrote. “Clearly, S&P 500 firms have found substantial capital for investment, notwithstanding large shareholder payouts.”
The merits of buybacks at the individual corporate level can only be assessed in hindsight. Sears, Nokia, General Electric and Xerox all spent billions on buybacks over an extended period, only to see there share prices subsequently post dramatic drops. Clearly, such funds would have been better spent bolstering their businesses.
Still, most buyback plans turn out to be wise investments. There aren’t many recent empirical studies available, but a 1995 study by the Journal of Financial Economics found that shares of firms that buy back stock subsequently beat their peers by 12.1% over the next four years.
That result is borne out by the PowerShares Buyback Achievers Portfolio (PKW), which has outperformed the large-cap blend fund category by around 2.6 percentage points per year over the past decade.
And that outperformance may be poised to continue as the amount of funds earmarked for buybacks may reach a record $650 billion this year, according to Goldman Sachs. That would break the $589 billion record established in 2007. Of course, tax reform gets much of the credit for that largesse. Firms now have higher levels of retained earnings that can be applied to internal investments, acquisitions, dividends and buybacks.
The PowerShares fund, which carries a 0.63 percent expense ratio, tracks an index of firms that have reduced their share count by five percent or more in the trailing 12 months.
Think about that for a moment. Any firm that starts buying back stock isn’t yet eligible for inclusion in this fund right away. It’s fair to wonder just how much money is being left on the table in those early quarters of an extended buyback plan.
Indeed, eight companies that announced plans in the last two weeks of February to buy back at least $1 billion worth of shares saw their stock prices barely budge, on average. (However, a ninth firm, QEP Resources, has seen its shares surge nearly 50 percent since then).
That “let’s wait a year” approach is also deployed by the SPDR S&P 500 Buyback ETF (SPYB). That fund gives relatively higher weightings to account for the size of buybacks that firms announce. Apple’s recent $100 billion buyback announcement will likely have a pronounced weighting the next time the fund’s portfolio is rebalanced. In contrast, the PowerShares fund uses a more traditional market cap-weighted approach.