Retail investors take note: Not every investment vehicle lauded by billionaire investors is good for the little guy.
Take stock buybacks. Carl Icahn loves them. Warren Buffett is a big fan. But these financial instruments come with risk—and not much long-term reward. That’s why even a skeptical Hillary Clinton has proposed a series of policies to discourage them, saying they waste shareholder money to enrich hedge funds and well-heeled activists. A number of economists have also argued that they are a big threat to the U.S.economy, since they are a guise used to prop up share prices.
How they work is simple: Companies repurchase their own stock, inflating paper profits without producing anything of tangible value—such as investing in R&D, wages or plants and equipment. Since 2004 more than $6.9 trillion went into them, according to data compiled by Mustafa Erdem Sakinç of The Academic-Industry Research Network.
According to Goldman Sachs, stock buybacks will surge by 18 percent in 2015, exceeding $600 billion and accounting for nearly 30 percent of total cash spending.
A further deep dive into the trend reveals some startling facts. Excluding recession years 2001 and 2008, dividends and stock buybacks have represented on average 85 percent of corporate earnings since 1998, according to analysts at S&P. And stock repurchases worth almost $2 trillion have helped buoy the bull market since March 2009, according to FactSet data compiled for CNBC.
“Excluding recession years 2001 and 2008, dividends and stock buybacks have represented on average 85 percent of corporate earnings since 1998.”
While a good low-risk bet for the C-suite, the reluctance to boost capital investment in operations, people and product has left companies with the oldest plants and equipment in almost 60 years. The average age of fixed assets reached 22 years in 2013, the highest level since 1956, according to data compiled by the Commerce Department, as reported by Bloomberg and S&P.
That could explain some of the weak productivity numbers in the U.S.
For retail investors, the truth that matters is this: Buybacks have little concrete relationship to how stocks perform, and there’s little evidence that suggests they’ll consistently help mom-and-pops drive above-market performance.
The verdict is largely the same in academic studies, data from market-information firms TrimTabs and FactSet, and in a CNBC review of the companies that have announced the 25 biggest share buybacks since 2012—which include three separate buybacks announced by Apple, which adopted the strategy partly to appease Icahn, who had amassed a stake in the world’s largest smartphone maker.
Getting help from professionals doesn’t make exploiting corporate buybacks any easier: Of the four exchange-traded funds that focus on companies that heavily buy back their shares, two have beaten the S&P 500 stock index in recent years, and two have trailed it.
“Buybacks tend to rise when stock prices rise, and fall when stock prices fall,” TrimTabs CEO David Santschi said. “Buybacks generally happen when top insiders are feeling confident enough to use shareholders’ money to support the value of their stock-based compensation. Most have nothing to do with buying at low prices.”
Companies that have executed the 25 biggest buybacks since the end of 2011 have risen 21 percent since, according to a CNBC.com analysis. (We assumed investors bought 100 shares of each company announcing a buyback at the closing price on the day of the announcement). That compares to 53 percent for the broader market. Of the 25 buyback stocks, just 11 have beaten the market since the repurchases were disclosed, and many have benefited from obvious macro trends.
Buffett’s advice on buybacks
For every Apple, which has delivered a 60 percent gain for investors who bought into each of its three buyback announcements, there has been an AT&T, which gained just 6 percent when it launched its buyback this year after shares had quadrupled since 2011. IBM, Qualcomm, Wal-Mart and Pepsico have lost money since their mega-buybacks began.
The results are similar in ETFs that try to exploit buybacks. The SPDR ETF that tracks S&P 500 companies that focus on buybacks has trailed the S&P index itself by nearly 3 percentage points over the past year. The star in the crowd is theTrimTabs Float Shrink ETF (TTFS), an actively managed fund that holds more than 200 stocks. It has beaten the S&P 500 by more than 30 percentage points since launching in late 2011.
That doesn’t mean buybacks aren’t sometimes a good tool. Buffett thinks they make sense when they’re deployed by more mature companies that can’t easily reinvest the money.
In the S&P 500 overall, returns for companies that buy back the most stocks beat the broader index handily, according to a report by research firm Aranca, although the heaviest-weighted performers among members of S&P’s buyback index are lesser-known names, such as Cameron International, which makes oil field equipment. Buffett himself says he weighs buybacks against acquisition opportunities, and buybacks during market dips are usually the better deal.
“Disciplined repurchases are the surest way to use funds intelligently: It’s hard to go wrong when you’re buying dollar bills for 80 cents or less,” Buffett said in Berkshire Hathaway’s 2012 shareholder letter. “But never forget: In repurchase decisions, price is all-important. Value is destroyed when purchases are made above intrinsic value.”
By Tim Mullaney, special to CNBC.com