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.
How have those distinct approaches impacted performance? Well, the SPDR fund only has a three-year track record at this point. But in that time, it has delivered a 9.55 percent return, more than three percentage points better than the PowerShares fund. And the SPDR fund’s 0.35 percent expense ratio is lower as well. Despite the marketing muscle of the SPDR platform, the fund has a surprisingly low $16 million in assets (compared to $1.3 billion for the PowerShares fund).
It’s worth noting that both funds have lagged the S&P 500 over the past three years. But as mentioned, the PowerShares fund beats the benchmark over the past decade.
The AdvisorShares Wilshire Buyback ETF (TTFS), a third entrant in the category, has two clear drawbacks: a stiff 0.90 percent expense ratio and very low trading volumes which can lead to bid/ask spreads in excess of 40 cents.
And that’s a shame, because the fund has a slightly better five-year track record than the PowerShares fund. This is a fund to keep on your watch list to see if its sponsor drops that high expense ratio. If it does, then perhaps trading volumes would rise and trading spreads would narrow.
TTFS excludes any firms that lard up their balance sheets with debt to fund buybacks, so in theory this fund should perform better in a market downturn or economic slowdown. In 2008, when firms were hunkering down and hoarding cash in the face of a possibly protracted recession, debt-heavy firms saw their stocks pummeled.
Make no mistake, buybacks can have a powerful impact on share prices. Just ask the investors of Home Depot. That firm’s share count has been reduced by more than 500 million since 2010, which has led to per share profits being 30 percent higher than they would otherwise have been. Still, for every Home Depot there is a Nokia or a GE. Using the ETF approach ensures that investors don’t end up betting on the wrong buyback horse.