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Saj Karsan
Saj Karsan
Articles (5983) 

Buybacks: In Style At The Wrong Time

December 27, 2010 | About:

Compared to dividends, buybacks provide a more tax efficient method of returning cash to shareholders. But any tax benefits may be more than reversed by the exceedingly poor prices at which corporations buy back their own shares.

Previously, we have seen anecdotal evidence of this, as we examined the recent buyback records of Wal-Mart, The Home Depot, Best Buy, Target and Lowe's. The higher the stock price, the more money these firms would pump into buying back shares, which was the exact opposite of what they should have been doing. For a more recent example, look no further than Netflix (NASDAQ:NFLX), which trades at a P/E of 70 and yet continues to buy back shares.

Anecdotal evidence can be misleading, however, and therefore it makes more sense to consider the aggregate market as a whole. The following chart depicts the level of buybacks for the S&P 500 over the last four years:


Note how well this correlates with the overall market. As the market peaked in 2007, firms were furiously buying up shares. As the market fell to its lowest level in March of 2009, companies were too scared to buy back shares. Yet, this is exactly when many companies (those not in debt trouble) should have been active in the market.

Today, companies in the aggregate appear to have regained their appetites for buybacks. But prices have recovered as well, so that even though buyback funds are almost four times higher than they were in the second quarter of 2009, they pack about 40% less punch per dollar. Seeing as how the top tax rate on corporate dividends in the US is 15%, perhaps investors in the aggregate would be better off with dividends over buybacks despite the tax hit.

Saj Karsan


About the author:

Saj Karsan
Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, and an undergraduate engineering degree from McGill University.

Rating: 3.5/5 (14 votes)


Jonmonsea premium member - 8 years ago
Do you not think WMT is at least 25% undervalued, given its international exposure and currency diversification?
LwC - 8 years ago    Report SPAM
" The higher the stock price, the more money these firms would pump into buying back shares…"

Hmmm, I can't help but wonder if it is in fact the opposite: The more money these firms would pump into buying back shares, the higher the stock price.

Ilovesummer - 8 years ago    Report SPAM

yes it seems these companies never buy back their stock cheaply so

it should go as dividends to shareholders instead
Sivaram - 8 years ago    Report SPAM

LwC touches on an important point that I also wonder about (it also touches on George Soros' reflexivity theory). Namely, what if prices are rising because of stock buybacks? What if the effect is actually the cause? Stock buybacks are sizeable these days and they can definitely change prices.

In a similar vein, I always wonder about retail fund flows into stocks. Quite often, money flows out when prices fall and prices rise when capital flows in. Usually this is observed as the so-called "dumb money" buying at the wrong time. But I just wonder...
Jhodges72 - 8 years ago    Report SPAM
Sivaram, the obvious argument against what you've presented is that, in the above chart, these buybacks occured when the market was already at X rather than the market going to X. To find your question, and I believe it's an important idea, one would want to investigate the individual companies themselves and I believe the answers would be easily obtainable.
Batbeer2 premium member - 8 years ago
If a company has excess cash is it not better to buy back stock than to pay a dividend (regardless of the stock price) ?

- For tax reasons.

- Because dividend policies can be dangerous. You pass the dividend in a tough year and half your shareholders run for the exits.

- A dividend at a high price still gives me a low IRR.

Many companies may be terrible at timing the market, but I don't see how investors could be better off with a dividend instead.
Hester1 - 8 years ago    Report SPAM

Academic research on returns of stocks that do large buybacks typically shows a large outperformance. Some show a massive outperformance. This doesn't gel with this article.

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