Most investors understand that Wall Street is full of smoke and mirrors and what you see is often not what you get. But now it turns out that even supposedly shareholder-friendly stock buybacks are not always what they seem. That is the lesson that a Citi Research report published yesterday attempts to teach, as analysts Todd Bault and James Naklicki argue that P&C insurance company stock buybacks are already expected by investors and thus are not likely to act as a significant catalyst for higher stock prices of the companies undertaking the buybacks.
Stock buybacks are cyclical
Bault and Nakilicki base their analysis on the fact that stock buybacks have historically been highly cyclical. “Stock buybacks are cyclical: they tend to decrease as pricing accelerates (with capital raises in extreme cases), and increase as pricing decelerates and declines.”
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Correlation between price increases and net capital issuance
The Citi analysts also focus on the strong historical correlation between price increases and net capital issuance in the sector. “From 1986 to 2005, the correlation of price increases to net capital issuance is strongly positive (69%). In the 3 hard markets of this period, there was net issuance caused by the cycle turns and net capital return all other times. Net capital return over this period was about 1% of surplus per annum, including issuance.”
Recent buybacks have not increased valuations
The report also points out that recent buybacks have not led to significant increases in company valuation. The analysts’ basic argument is if recent buybacks haven’t helped valuations, why should future buybacks be any different? “Recent buybacks have already increased versus history, and this has not noticeably increased valuations, absolute or relative. Average capital return was 3% of surplus per annum during 2006-13, and 4% during 2011-13. Yet post-crisis (2010-13) average valuations remain below pre-crisis (1980-2007), whether measured absolutely (1.04x book vs. 1.27x) or relatively (0.47x relative book vs. 0.55x).”