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Skip the dividends, look at buybacks Add to ...

Still hungry for dividends? Recent trends suggest that chasing after companies that buy back their own shares might be a more profitable pursuit.

Ever since the onslaught of the financial crisis, companies have been trying to make their balance sheets bullet-proof by building up impressive levels of cash. They've succeeded: Cash holdings as a percentage of market capitalization are at record levels.

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However, executives generally remain too cautious to commit to bigger dividends, or ambitious acquisitions for that matter - and that leaves share buyback programs as an increasingly popular way to shed excess cash. The upside for investors: When companies buy back their own shares, earnings on a per share basis tend to rise, potentially giving stock prices a boost.

According to Standard & Poor's, the dollar amount of stock buybacks for companies in the S&P 500 surged 37.2 per cent between the third and fourth quarters of last year, to $47.8-billion (U.S.). The number of companies participating in buybacks is also up: 214 companies bought their shares in the fourth quarter, up from 195 companies in the third quarter and 169 in the second quarter.

In Canada, the trend is even more pronounced. According to CIBC World Markets, members of the S&P/TSX composite index bought $5.5-billion (Canadian) worth of their own shares in the fourth quarter, up fivefold over the previous quarter.

"While rising buyback activity is a plus for shareholders, it's also a sign that Canadian firms are cautious for the time being about using their growing cash piles to ramp up capital spending," said Peter Buchanan and Meny Grauman, economists at CIBC World Markets, in a note.

This is a global trend, of course. And Jonathan Golub, a strategist at UBS, thinks it will persist even as executives grow more confident in the economic recovery, due to the fact that the financial crisis was severe and the economy continues to face a number of well-publicized risks. As a result, dividends and mergers and acquisitions activity will not keep up with rising earnings.

For example, he sees S&P 500 earnings rising 48 per cent over the next two years, but dividends rising only 9 per cent in 2010 and 11 per cent in 2011.

"While there is a big focus on dividends currently, when it comes to the repatriation of cash, we believe the real action will be in buybacks," Mr. Golub said. "During the last upturn, buyback activity increased dramatically, from a quarterly rate of roughly $25-billion (U.S.) per quarter in 2003 to an average of over $125-billion per quarter in 2007."

So far, information technology stocks and consumer staples have been big buyers of their own shares in the United States. In Canada, financials lead the buybacks, followed by information technology companies and consumer discretionary firms.

However, not all buybacks reward investors equally. Mr. Golub recommends focusing on companies that have a record of "disciplined buying," or buying their own shares at reasonable prices.

Follow on Twitter: @dberman_ROB

 

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