As a value investor, one of the metrics I often look at when analyzing a particular company is whether the company management is acting in a “shareholder friendly” manner. Part of that analysis involves looking to see if they have bought back stock over the years – and what valuation level they paid. I do consider it positive if the company regularly reduces their share count, as long as they are not using high cost debt to finance it, or paying exorbitant valuation multiples to buy it.
Buying back stock reduces the share count. All things being equal this helps improve the EPS of the company. This is a metric used by many – if not all – investors when they look at the valuation level of the company’s stock. Since many individual investors don’t do as much research as they should, they find it a convenient yardstick to compare EPS levels and the growth of eps as an easy comparable across various companies. This may entice them to buy the stock of the ones they see growing consistently or more quickly – pushing up demand for the stock, and expanding its valuation.
Company CEO’s know this truism as well – and you will find their bonuses often tied to stock performance – one of the biggest reasons CEO’s are quick to cite stock buybacks in their list of achievements.
So – Are Stock Buybacks Good or Bad?
Well, they can be both in my opinion.
If I see a company consistently buying back its own shares, at attractive valuations and using free cash flow, or prudent use of debt, I consider that to be shareholder friendly and a positive.
But that’s not always the case.
Many companies have been borrowing cheap debt – as the Fed has held rates near zero for so long – and using it to buy back shares of richly valued stock.
Total US non-financial debt in the corporate sector is now at an all-time record high of $13.7 trillion, with nearly $2 trillion of that being added just since 2012. And it’s without question they are using some of that debt to reduce their share count. In fact, since 2012, companies have bought back $2.7 trillion of stock. Even worse, companies tend to buy back their stock at the wrong time relative to stock valuation.
If you look at the data, stock buy backs peaked in the last equity market cycle in 2008 – right before the financial crisis, and they bottomed in late 2009 early 2010 – almost exactly at the bottom of the market correction. So where are we now? We’re right back up to the previous peaks in 2008.
Bottom line? Stock buybacks can be beneficial to investors owning the shares of companies making prudent use of free cash flow or low cost debt buying at attractive valuations, but beware those companies doing the opposite.
About the Author
Randy has more than 15 years of experience managing financial assets for individuals, retirement plans and businesses. Randy joined YHB | Wealth Advisors in January of 2018 and serves as the Director of Wealth Management. Prior to entering the professional wealth management field, he enjoyed building entrepreneurial business ventures from start-up to eventual sale and providing accounting services for public and private firms.