Over the last 18 months, U.S. companies have announced nearly $1.5 trillion worth of buyback authorizations. The list of companies participating in buybacks is already quite lengthy and only continues to grow.
Last year alone, investors saw more than $1 trillion in these announcements – the largest amount ever. This included sizable announcements from large companies like Apple (AAPL) and Cisco Systems (CSCO), as well as smaller announcements from small- and mid-cap companies.
But, like most things, not all buybacks are created equal. On the one hand, they can signal the outlook corporate insiders have on their respective company and whether they believe the stock to be undervalue in the market. But buybacks can also be used as a corporate ploy to buoy a stock price. The difference is critical when choosing what companies to invest in.
This year is shaping up to be an interesting year for buybacks – a strong start to the year has since tapered thanks in large part to the on-going trade war and uncertainty about the future. As these announcements continue to be made, even if in smaller volumes, investors should reference three key factors that when working in conjunction, can serve as a strong indicator for opportunities in the market:
Assess the size of the buyback
The case for large buybacks comes down to proportion: the bigger the better. Buybacks that represent a larger proportion of a company's outstanding shares tend to perform better.
In an analysis by EquityCompass Strategies of 10,070 unique buyback announcements from December 1995 to April 2010, companies that announced a buyback greater than 10% of outstanding shares outperformed the S&P 500 (.SPX) by 3.26% over the next month. In other words, a $1 billion buyback for a $100 billion market cap, or 1% of outstanding shares, isn't nearly as meaningful as a $100 million buyback for a $1 billion market cap company, or 10% of outstanding shares.
Comparatively, companies that announced a buyback that equated to less than 5% of outstanding shares outperformed the S&P 500 by only 1.77% over the following month. (This is based on one month forward returns following the buyback announcement relative to the S&P 500.)
Consider the timing
Buyback announcements tend to reflect positive sentiment, particularly when that sentiment is resounding. They serve as an indication of how companies view the future.
Consider last year. A steady economy combined with new tax legislation resulted in a record-setting year for buybacks. This year, on the other hand, buybacks have slowed as trade tensions continue to escalate. Such activity, or lack thereof, indicates a business environment where companies are generally more nervous and less willing to put excess cash to work.
Timing, then, becomes an important factor. When a company announces a buyback during times of volatility, or during a slowdown in overall buybacks, it could signal a strong investment opportunity.
Altice USA (ATUS), a telecommunications and media company, announced a 29.1% buyback on July 31, totaling $3 billion at a time when companies dramatically cut back on new buyback announcements.
This followed a strong earnings report and the completion of $600 million in buybacks in the second quarter (bringing the total repurchased shares to $1.2 billion 2019 year-to-date). Since the announcement through Sept. 13, ATUS outperformed the S&P 500 TR Index by +12.67% (13.91% return versus 1.24% for the S&P 500).
PDC Energy (PDCE), which produces and distributes petroleum products, announced a $325 million, 20.56% increase to their buyback program on Aug. 26, in conjunction with an announcement of a strategic combination with SRC Energy.
Also in that announcement, PDC outlined a completed $125 million in buybacks for the year to date, and plans to utilize an estimated 50% of the expected $800 million in free cash flow in the period from 2019 through 2021 to complete the remaining $400 million authorized under its buyback programs (representing 23% of all outstanding shares). From the close on Friday Aug. 23 to Sept. 13, PDCE outperformed the S&P 500 by +23.64% (29.43% return versus 5.79% for the S&P 500).
Identify the trends
Individual company buybacks can hold more weight when they're part of a larger trend. Take, for example, industrials.
Between July 2017 and February 2018, industrials companies announced $7.9 billion in buybacks per month, on average. In March 2018, when industrials were first impacted by the trade war, companies only announced $0.26 billion in buybacks. Announcements rebounded to higher but below-average levels in April and May, but then significantly dropped back down as trade tensions escalated.
Overall, from March until June, the buyback announcement pace for industrial companies dropped by almost 60%. From February 2018 through the end of the year, the industrials sector underperformed the S&P 500 TR Index with a -14.30% return versus -6.10% for the index.
The opposite is also true. Last year, companies in the technology sector dominated buyback announcements, accounting for 34% of all authorized share repurchase programs. The S&P 500 technology sector finished the year down just 0.29% compared to the S&P 500 TR Index down 4.38%.
Individually, these factors can hint at an investment opportunity. That signal is compounded when combined – when two or more of these factors are present in a buyback, it's more likely to be a stock worth watching. But these factors should not overshadow the economic landscape.
Take Dick's Sporting Goods (DKS), for example, which is a sporting goods retailer that has faced volatility in lieu of new tariffs. The company announced a 31.69% buyback on June 12th, amounting to $1 billion. Since the announcement on 6/12 through 9/13, DKS is outperforming the S&P 500 TR Index by +10.50% (15.49% return versus 4.99% for the S&P 500 TR Index).
Although the large buyback and execution on the buyback makes DKS a compelling opportunity, investors should be prepared for headline risk. DKS was significantly outperforming the S&P 500 in late July but was then underperforming by early August with recent outperformance relative to the S&P 500 happening again in September.
As companies continue to authorize buybacks, investors can cut through the clutter by looking at three factors: size, timing and trends. Buybacks will continue to be significant transactions in the markets and, with the proper analysis, informed investors can pinpoint which buybacks are worth their attention.
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