This week S&P Dow Jones Indices (S&P DJI) reported preliminary data indicating that S&P 500 stock buybacks (shares repurchases) fell 17.5% in the first quarter of 2017 to $133.1 billion from $161.4 billion in the first quarter of 2016. For the 12-month period ending March 2017, S&P 500 companies spent $508.1 billion on buybacks, down 13.8% from the prior 12-month period.
According to S&P DJI, this decline in share repurchases comes at a time when companies are reporting strong earnings and record levels of cash. There is speculation that the slowdown in buybacks is due to a lack of faith that a tax overhaul will come in 2017. In addition, as stock prices have risen, the need for companies to actively support their share prices has fallen.
The S&P DJI report states that fewer share buybacks mean less earnings per share (EPS) support. Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices said in the report that “companies may have to increase EPS the old-fashioned way—by earning it.” S&P 500 companies reducing their year-over-year share count by at least 4%, an amount large enough to affect earnings per share, declined to 14.8% in the first quarter compared to 28.2% a year ago.
The S&P DJI data shows that the financial sector increased its expenditures on share buybacks by 10.2%, to $29.5 billion, the most of any S&P sector. Health care expenditures declined 6.5%, to $27.0 billion.
Given this data, I examined the buyback behavior of the stocks in the SSR tracking portfolio. I used AAII’s Stock Investor Pro fundamental stock screening and research database to study the buyback yields of the 36 current SSR stocks over the last several years.
A stock’s buyback yield is determined by comparing the average shares outstanding of one fiscal period with the average shares outstanding of another fiscal period. In this case, we are comparing the average shares outstanding over each of the last seven fiscal years. If a stock had 90 million average shares outstanding in its latest fiscal year compared to 100 million average shares outstanding in the prior year, the buyback yield for the latest year would be 10.0%. Conversely, if a stock had 100 million average shares outstanding in its latest fiscal year and had 90 million average shares outstanding in the year prior, it would have a buyback yield of -11.1%. Note that the signs are reversed; a positive buyback yield indicates the average number of shares outstanding declined, while a negative number indicates the average number of shares outstanding increased.
Typically a company’s number of outstanding shares declines because the company is buying back its shares, although this can also be accomplished through a reverse stock split. The theory is that if a company is buying back its shares, management must feel that the shares are undervalued, so it is taking advantage of the opportunity to purchase their shares at a discount. It is also another way by which a company can support the share price for shareholders. Therefore, it can be seen as a “payment” made by the company to shareholders in lieu of a cash dividend. According to academic studies, stocks with high buyback yields should provide better performance than those with low buyback yields.
Eighteen of the 36 SSR stocks, on average, have reduced their average annual share count over the last seven years.
As investors, it is worthwhile to pay attention to a company’s share buyback behavior. Some companies are able to boost their earnings per share exclusively by reducing the number of shares outstanding. This is why it’s useful to examine the trend in net income along with earnings per share. If net income is flat or declining, but earnings per share are increasing, you know that the company is boosting EPS through share buybacks. As long as the company keeps repurchasing shares, EPS will be supported. However, if a company scales back or stops its share repurchases, and net income is not improving, earnings per share growth will become flat or decline.