High Conviction Buybacks: Turns Out, CEOs Aren’t Stupid by Mebane Faber, The Idea Farm
I’m surprised this article didn’t get more coverage in the financial media. I sent a summary earlier but here is the full article from OSAM on buybacks.
One chart then the study:
Carlson Capital's Black Diamond Arbitrage Partners fund added 1.3% net fees in the first quarter of 2021, according to a copy of the firm's March 2021 investor update, which ValueWalk has been able to review. Q1 2021 hedge fund letters, conferences and more At the end of the quarter, merger arbitrage investments represented 89% of Read More
High Conviction Buybacks by Patrick O’Shaughnessy
Money spent on share buybacks is approaching the previous high set in 2007–08, and this has some investors worried. But hidden beneath the aggregate statistics on buybacks are important nuances that matter for investors. Firms repurchase shares at different levels of conviction and that level of conviction can help differentiate between an attractive investment opportunity and useless information.
Most of the dollars spent on buybacks come from what we classify as low conviction share repurchase programs: firms repurchasing between zero and five percent of their shares over the past year. More interesting are firms that vote more aggressively—for better or worse—on their own share price, repurchasing more than five percent and sometimes even greater than ten percent of their shares in just a one-year period. History suggests that these high conviction firms signal an opportunity for investors.
A common criticism levied against buybacks is that corporate managers mistime their repurchases, buying back stock at expensive prices. But this hasn’t been true for the high conviction buyback firms. Since 1987, roughly half of all high conviction buybacks conducted by large U.S. firms were conducted when the firm’s stock was in the cheapest quintile of all large stocks; fewer than ten percent of high conviction buyback firms bought back shares when they were in the most expensive quintile of the market. The same numbers for low conviction firms? Only 28 percent bought back shares while their stock was in the cheapest quintile and roughly 20 percent bought back shares in the most expensive quintile. There is a clear historical relationship between buyback conviction and cheapness.
Even more important for investors, these high conviction buyback stocks have outperformed the market consistently through time.
This paper explores the current buyback landscape for U.S. stocks and highlights the potential edge given to those who invest alongside high conviction buyback firms.
Sure enough, we are reaching peak dollar amounts on a rolling 12-month basis. But these are just raw dollars being spent—it doesn’t tell us much about the magnitude of the buyback programs going on, which is a crucial detail.
A firm that repurchases ten percent of its shares in one year is much different than a firm that repurchases two percent. To put it another way, if Apple ($740 billion market cap) spends one billion dollars on repurchases, it’s much different than if Marathon Petroleum ($30 billion market cap) spends a billion dollars. Arguably, the billion spent by Marathon would represent a higher conviction in their own share price by Marathon’s executives. They would be making a much bigger bet.
Total cash spent on buybacks based on buyback conviction level can be separated into groups: the low conviction group has repurchased between zero and five percent of their shares in the past year, the higher conviction group has repurchased between five and ten percent of their shares, and the highest conviction group has repurchased more than ten percent of their shares. When you add up the totals, it becomes clear that most of the raw dollars being spent on buybacks come from the low conviction group. Figure 1 shows all firms with a positive net buyback over the past year and breaks out the total amount of cash coming from all three levels of buyback conviction at each point in time, which add up to the market’s overall buyback amount (black line).
See full PDF below.