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Stock Buybacks! A Fad? Do they work?

Buyback Programs – are they a fad?

Since the market crash in 2008 it seems that all big investment funds talk about when they make a large equity purchase is the fact that the company needs to add a buyback program. This is their way of eliminating share dilution and insuring that their piece of the pie becomes more valuable as time progresses. The question I have is, was this as common prior to the crash? How many companies are really doing buyback programs now compared to even ten years ago?

Here is an example of a backtest where we looked for all companies that decreased their shares outstanding over the past year. It beats the market, but only barely. On top of that, there isn’t a really meaningful increase in companies that are decreasing their outstanding shares in that time.

What about bigger companies?

Many large firms, like Berkshire Hathaway, focus on companies with larger market caps as they have been around longer and are less likely to fail in the near future. What happens if we put in a parameter that only grabs companies that are decreasing their shares outstanding and have a market cap of greater than $3 billion?

There we go! We see a noticeable change in the number of companies that match the screener as time goes on. However, it does look like our performance suffers and that we return almost equal what the S&P returns – and we do so at a higher standard deviation meaning our strategy takes on more risk for what is essentially the same return.

What about the extreme case?

Here we look for companies that retired 10% of their shares last year. ​​ That’s a lot of shares! ​​ As a convenience, we include the large cap and buying back shares (though not at the 10% level). ​​ 

As you can see, this is not a win. ​​ How about mixing both changes, to look only at large stocks with large buybacks?

That works better! ​​ So, are buybacks a fad? In short, no. Buybacks are just currently the best way to approach these large sum investments into these established (read: larger) companies. Are buybacks a harbinger of outperformance among large caps? ​​ Likely not. ​​ Notice that the bright green line (our “optimal” strategy) had a larger standard deviation. ​​ 

We are a victim of the law of small numbers. ​​ Smaller groups of stocks are more likely to have more extreme performance. ​​ At this level we can see that there’s essentially no alpha to be gained from buyback hunting.

Henry Crutcher is an avid family guy, board gamer (think Settlers of Catan, Puerto Rico, etc), computer nut, and all around geek. Hailing from Louisville, KY, he has noticed that the weather in Louisville is remarkably similar to the weather in Atlanta, GA despite the 407 miles that separate them. He has two daughters, one cat, and lots of trees. He loves the Miles Vorkosigan series from Lois McMaster Bujold, for its mix of SF, comedy and insight into how people work. He also comsumes more than his fair share of cheesy business/economics books, such as The Ascent of Money by Niall Ferguson, or Farewell to Alms, by Gregory Clark.

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