Wall Street celebrates stock buybacks by companies, as they are seen as a sign of confidence for the future.
Bradley Safalow, a veteran researcher in the stock market warns investors to be cautious.
Barron’s published a report that echoed Safalow’s assertion. While buybacks may boost stock prices in the short term, they can have a negative impact on long-term performance, especially for firms with weak financial and operational foundations.
Buyback Paradox: Big Spenders and Underwhelming Results
Safalow’s research shows a surprising trend: the companies that have the biggest buyback programs within the S&P 500 index underperformed over the last decade.
He compared stock buybacks with a sugar rush, which is a temporary spike in shares prices but leaves many companies weaker over time.
S&P 500 Companies repurchased shares worth $3.5 trillion between 2019 and 2023.
Although many of these expenditures were made, they did not result in a significant reduction of the outstanding shares due to compensation increases.
A small number of companies have achieved net shares reductions of over 4%.
Buybacks are not a good use of capital for companies that have high debt levels or face structural problems.
Safalow cites examples like ITT Educational Services or Big Lots that spent more than $1 billion in buybacks, before ultimately filing bankruptcy.
Buybacks: Avoiding the traps of poor timing
Safalow’s criticism is in line with research from academics and the insights of seasoned investors such as Leon Cooperman who has long noted that managers frequently mistime their buybacks.
During a downturn, companies often buy stock at high prices only to sell it back when the shares become undervalued.
Cooperman noted that “most management teams do not have a good understanding of the intrinsic value” in their business.
Safalow agrees, stating that buybacks are only appropriate when the stock of a firm is undervalued.
Companies that do it right: Buyback Outliers
Some companies, in spite of the criticisms, have been able to effectively use buybacks, creating substantial value for shareholders.
Safalow recommends that investors buy shares in AutoZone and Dillard’s.
The companies that have made the most stock purchases at the right times are those who contributed to the strong performance of the Russell 2000 and S&P 500 over the last five years.
Safalow released a “Buyback outliers” list in December. This is a listing of companies that have disciplined buyback policies, even when the market has been weak.
These firms must consistently produce free cashflow, high returns on investment, and low share-based compensation levels to qualify.
Safalow has a list of notable people, including:
Charter Communications Charter Communications has demonstrated strategic timing with its buybacks. This is backed by strong cash flows.
Williams Sonoma: Thanks to a disciplined capital budget and a prudent buyback program, the retailer outperformed.
Etsy & Polaris: Both companies are among the smaller firms that have used share buybacks effectively to increase shareholder value.
Stock-based Compensation: An overlooked Cost
Safalow is concerned about the impact that stock-based compensation has on the real effect of buybacks.
Despite the fact that stock-based compensation is a cost for shareholders, many companies have been able to convince Wall Street to ignore it when calculating adjusted profits.
Stock-based compensation can exceed 15% of cash flows at some consumer discretionary and tech firms. This dilutes the benefit of stock buybacks.
Safalow claims that buybacks are often used by companies to hide these costs and create a false picture of their financial health.
Investors can learn from these lessons
Safalow’s research offers investors important insight into the landscape of buybacks:
Don’t be fooled by large-scale buybacks: A high buyback program doesn’t always translate into strong returns on the long term.
Assess management timing and strategy. Search for companies who repurchase their shares at low prices, instead of chasing higher valuations.
Focus on cash flow and capital efficiency. Companies with a disciplined capital allocation, and limited stock-based rewards are more likely than others to achieve sustainable returns.
Safalow’s “Nice List” of Buyback Outliers can be a good starting point for investors looking to find opportunities.
The companies in this list show that buybacks, when done thoughtfully, can be an effective tool to increase shareholder value.
The post Share Buybacks Dominate 2024: Here’s Why Not All Buybacks Are Worth It may be updated as new developments unfold.
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