Corporate cash balances currently sit at an all-time high. As interest rates are still at a record low this is somewhat surprising and indicates that companies just aren’t spending, or investing.
Cash spending on buybacks
That being said, one thing that has been on the rise is the amount of cash spent by companies on stock repurchases. But is the right thing to do? As the market sits at an all-time high and many stocks are hitting 52-week highs, it does not make sense to spend shareholder cash repurchasing, what could be described as overpriced stock.
Warren Buffett has previously commented that using company cash to repurchase seemingly overpriced shares, is a betrayal of shareholders and indicative of bad management. This is not a view held by all investment managers but it is one I tend to agree with, as a value investor.
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Corporate Buyback Scorecard
Institutional Investor attempted to answer the question of whether or not stock repurchases were ill timed by putting together the Corporate Buyback Scorecard during 2012. Although this study is several years old, it is still relevant, as managements that have achieved the best returns in the past are likely to continue that trend in the future.
The Scorecard takes into account the timing of the buyback as well as the return-on-investment, or ROI. The effectiveness of the buyback is measured using the same metrics many companies will use to value a new investment, a ROI hurdle rate of 10%; buybacks should be held to the same standard. Bear in mind that this study was conducted during the period 2010 to 2012, when stock prices were significantly lower than they are now, implying that any buyback program which resulted in a poor ROI then is likely to have generated an even worse ROI now that share prices are at an all-time high.
ROI on buybacks
So, what did the study reveal? Well, of the 253 companies surveyed, around half achieved a ROI of less than 10%. The median buyback cost $1.2 billion and produced an ROI of 7.7%. The technology and hardware sector performed worst with a ROI of -12.3%. Surprisingly, one of the worst individual performers was Goldman Sachs Group Inc (NYSE:GS), which spent $9.8 billion buying back stock during the period, only to produce a ROI of -20%. Unfortunately, for Netflix, Inc. (NASDAQ:NFLX)’s investors, Scorecard places the company in dead last as the company spent hundreds of millions buying back stock in the period studied, only to find that it had run out of cash, which led to issuing more stock, undoing all of its buybacks. The company produced a buyback ROI of -51.9%.
Nevertheless, the positive takeaways from the study are thus: The industry with the most effective buybacks has proven to be the telecoms sector with an average ROI of 38.7%. On an individual basis, American International Group Inc (NYSE:AIG) achieved the best ROI of the 253 companies studied, producing a buyback ROI of 76.9%. Seagate Technology PLC (NASDAQ:STX) came in second with a buyback ROI of 73.5%. Discover Financial Services (NYSE:DFS) and Dollar Tree, Inc. (NASDAQ:DLTR) also ranked highly with a buyback ROI of 64.6% and 61.4% respectively. Netflix, Inc. (NASDAQ:NFLX) sits at the bottom of the list, as already covered but the company is joined by Electronic Arts Inc. (NASDAQ:EA), Juniper Networks, Inc. (NYSE:JNPR) and Hewlett-Packard Company (NYSE:HPQ), which produced buyback ROI’s of -42%, -35.6% and -34.7% respectively for the period surveyed.