Richard X. Bove & Satyam Arora, Vice Presidents Equity Research at Rafferty Capital Markets, discuss stock buybacks do not create value.

Basis of Vigorous Debate

Clearly, in recent days I have been focusing on the value proposition proposed in bank investment. To this point it has been argued that the industry

Has offered no proposition of value to its investors (Does the Banking Industry Have A Value Proposition For Investors?: Rafferty Capital Markets, August 11, 2016) but that

Such a statement could be created based on the industry’s core business of taking in deposits and making loans (Deposits and Loans: Rafferty Capital Markets, August 13, 2016).

This comment argues that the leading point in the industry’s value proposition to investors – stock buybacks — is not credible. The industry’s argument is not based on empirical results as best I understand them. In a report entitled No Evidence That They [Stock Buybacks] Push Up Bank Stock Prices (Rafferty Capital Markets, August 9, 2016) it was demonstrated that:

There does not appear to be any statistically valid correlation between stock price movements and stock buybacks going back to the year 2000.

In fact, to the degree that there is any correlation in recent years it has been a negative one.

This commentary simply provides more empirical data on these assertions. It provides charts of 18 banks indicating the lack of correlation.

Theory

In 1991, Joel Stern and G. Bennett Stewart began defining their theory of Economic Value Add in a book entitled Quest for Value. In this book the consultants articulated the view that it made sense for companies to borrow money at low rates to buy back their stock.

Cogent arguments were made explaining that earnings per share would rise. The rise in the company’s earnings per share and possibly its book value would then translate into higher stock prices.

In recent years, this theory has almost become a religion. There has been a burst in stock repurchase activity. Banks have been at the forefront of the movement. Their investors have continually demanded that companies repurchase large amounts of outstanding stock when possible. It seemed to make greatest sense to do this when bank stock prices were below book value.

Not all theoreticians have agreed with this theory, however. It has been pointed out that lowering a bank’s capital may lower its secular growth rate. Further, that by reducing common equity and increasing debt, a bank weakens the strength of its balance sheet. Moreover, by buying back stock rather than re-investing available capital implies that the companies no longer have growth opportunities.

It is estimated that the 18 banks in this report spent $135.3 billion on stock buybacks in the past 6 years. They may have actually lost $14.5 billion in net income as a result of these purchases. This loss will happen every year. They will never get this money back. They apparently lost this money due to a desire to give $135.3 billion to people who do not want to own their stocks.

Fact

In the 25 years since the Stern Stewart theories were first propounded, there has been ample time to test their views in the marketplace. We have attempted to do this by looking at the 18 banks stocks selected using data, provided by SNL Research, from 2000 to 2016. As noted above the results seem to suggest that buying back stock does not increase shareholder wealth.

Question

If our results are as compelling as it appears, the question arises as to why banks are spending over a hundred billion dollars on a theory that cannot be validated by empirical events. Are managements actually harming shareholders by doing this? Should they be asked to provide some data that proves that they are not weakening their companies by shoveling the firm’s capital to people who are using it to sell the bank’s stock?

Bank of America (BAC); Rating – BUY; 12 Month Price Target – $19.00

Value Proposition - Stock Buybacks Do Not Create Value

From 1Q 2011 to 2Q 2016, BAC share price decreased 4.5% whereas the S&P 500 rose by 58.3%. BVPS was up by 11.9% and price to book was down by 14.7%. EPS was up. As a result of $9,652 million spent in buybacks, the bank will lose $0.07 per share per year indefinitely. The correlation between share repurchase and price movement is 0.06 for the said period.

Value Proposition - Stock Buybacks Do Not Create Value

Citigroup (C); Rating – BUY; 12 Month Price Target – $50

Value Proposition - Stock Buybacks Do Not Create Value

From 1Q 2011 to 2Q 2016, Citigroup share price decreased 9.9% whereas the S&P 500 rose by 58.3%. BVPS was up by 25.4% and price to book was down by 28.1%. LTM EPS was up by 56.0%, but PE ratio was down by 42.2%. As a result of $10,161 million spent in buybacks, the bank will lose $0.26 per share per year indefinitely. The correlation between share repurchase and price movement is -0.13 for the said period.

Value Proposition - Stock Buybacks Do Not Create Value

JPMorgan (JPM); Rating – BUY; 12 Month Price Target: $76.50

Value Proposition - Stock Buybacks Do Not Create Value

From 1Q 2011 to 2Q 2016, JPM share price increased 34.7% whereas the S&P 500 rose by 58.3%. BVPS was up by 44.6% and price to book was down by 6.8 %. LTM EPS was up by 31.1% and PE ratio was up by 2.7%. As a result of $30,217 million spent in buybacks, the bank will lose $0.91 per share per year indefinitely. The correlation between share repurchase and price movement is -0.50 for the said period.

Value Proposition - Stock Buybacks Do Not Create Value

Wells Fargo (WFC); Rating – HOLD; 12 Month Price Target: $51.00

Value Proposition - Stock Buybacks Do Not Create Value

From 1Q 2011 to 2Q 2016, WFC share price increased 47.2% whereas the S&P 500 rose by 58.3%. BVPS was up by 52.6% and price to book was down by 3.6%. LTM EPS was up by 66.7%, but PE ratio was down by 11.7%. As a result of $34,044 million spent in buybacks, the bank will continue to lose $0.84 per share per year indefinitely. The correlation between share repurchase and price movement is -0.32 for the said period.

Value Proposition - Stock Buybacks Do Not Create Value

BNY Mellon (BK); Rating – BUY; 12 Month Price Target – $44.00

Value Proposition - Stock Buybacks Do Not Create Value

From 1Q 2011 to 2Q 2016, BNY Mellon share price increased 28.6% whereas the S&P 500 rose by 58.3%. BVPS was up by 25.9% and price to book was up by 2.1%. LTM EPS was up by 80.0%, but PE ratio was down by 28.6%. As a result of $8,156 million spent in buybacks, the bank will continue to lose $0.72 per share per year indefinitely. The correlation between share repurchase and

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