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A way to find value

Here’s why you may be able to generate alpha from companies that buy back their stock.

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You know that investors can buy and sell shares. But did you know that companies can buy their own shares as well? This is known as a share repurchase. If you’re looking for investing opportunities, there are a number of reasons to consider the stock of companies that have recently repurchased their own shares.

Past performance is no guarantee of future results, of course. However, companies have historically delivered positive relative returns after buybacks in general, with particularly strong results among those that completed large share repurchases. Consequently, identifying share repurchasers as an investment opportunity may be an attractive strategy.

What is a share repurchase?

Share repurchases occur when companies buy back their own stock that was previously issued on the open market.1 This action can also be referred to as a “stock repurchase,” “share buyback”, “stock buyback,” or simply a “buyback.”

Companies repurchase shares for a variety of reasons, and they typically complete the buyback on the open market, through private negotiations, or by a tender offer (an open, public offer) to shareholders.

Buybacks are generally good for a company’s stock

Investors commonly view buybacks as increasing shareholder value, and therefore, as having a positive impact on the stock.

Based on historical analysis of S&P 500 companies before and after buybacks since 1990, we find that management tends to repurchase shares after periods when their stock has underperformed the market—represented by the equal-weighted S&P 500® Index. In our study, the average underformance in the 12 months preceeding the buyback was by 1.95 percentage points (see the chart, right).

Why might companies repurchase their shares after a period when their stock has underperformed? A primary reason may be to signal to the market that their stock is undervalued. Based on subsequent stock performance following the buyback, these companies have generally been correct.

Share repurchasers generally delivered positive absolute returns over the 12 months following their buybacks (see the chart below). Hypothetical portfolios of share repurchasers produced an average return of 13.64% during the 12 months following the buyback. To put this into perspective, companies that did not repurchase their own stock produced lower average returns of 12.12%.

Along with producing positive absolute returns, companies that repurchased shares also outperformed the market by 0.83 percentage points over the next 12 months. Those repurchasers that bought back more than 5% of their total shares delivered even better results, with a 12-month forward relative return of 4.79 percentage points.

Moreover, a hypothetical portfolio of large repurchasers (i.e., companies that buy back more than 5% of their shares) outperformed the market during 72% of months—more frequently than a hypothetical portfolio of all repurchasers (57%). In addition, this outperformance continued beyond 12 months for large repurchasers. During the 12- to 24-month period after their buybacks, the relative returns of large repurchasers averaged 0.75 percentage points.

How does frequency of buybacks potentially impact performance?

Some companies continually repurchase their shares. Have large, serial repurchasers (those that frequently repurchase their shares) performed better after their buybacks? Perhaps not.

Large share repurchasers that consecutively repurchased shares delivered relative returns of 3.19 percentage points over the following 12 months. Conversely, those that did not consecutively repurchase their shares outperformed by 5.81 percentage points on average (see the chart below).

This suggests that unlike the serial repurchasers, infrequent, large share repurchasers surprised the market with their buybacks and subsequently experienced the highest 12-month forward outperformance.

Investment implications

Share repurchase is a powerful tool, and investors may be able to benefit from its signaling effect. A number of the biggest companies have executed large buybacks recently (see the table below).


Largest share repurchasers over the past 12 months by % change in shares outstanding
American International Group, Inc (AIG) (14.6)
The Dun & Bradstreet Corporation (DNB) (13.4)
DIRECTV (DTV) (13.2)
Lam Research Corporation (LRCX) (12.7)
General Motors Company (GM) (11.6)
Pfizer Inc. (PFE) (11.4)
Yahoo! Inc. (YHOO) (10.8)
O’Reilly Automotive, Inc (ORLY) (10.8)
St. Jude Medical, Inc. (STJ) (9.4)
Seagate Technology PLC (STX) (9.2)
Source: Compustat, S&P, as of October 14, 2013.

Historically, the best performers among share repurchasers have been those that repurchase infrequently and in large amounts. Look for them, conduct a thorough fundamental analysis, and you may be able to generate alpha.

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Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.
Information provided herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any security. Discussion of individual securities is not intended to represent holdings of any Fidelity fund or investment product.
1. We define share repurchase as a decrease in common share count over the past 12 months—a measure that takes into account share issuance due to mergers and acquisitions but excludes preferred share transactions.
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