Most fundamental investment approaches attempt to calculate a company’s intrinsic value. Investors then attempt to exploit discrepancies between that intrinsic value and the market value. The problem with these approaches is that it is impossible to know exactly what intrinsic value is. The liquidity theory offers an alternative to traditional stock selection strategies. Taking a clue from basic supply and demand, it holds that if the same amount of money is chasing a smaller amount of shares, the price should increase, all else being equal.
Insiders of a firm know more about its fundamentals than the general public, and these insiders can influence the price of their shares by timing the company’s stock buybacks to their advantage. Stock buybacks are a powerful force that helps to push stock prices higher. More and more companies have been slapping buy ratings on their own stocks, which they view as undervalued, at a time when individual investors are parking their cash in bonds and money market funds.
Focusing solely on stock buybacks can, however, be problematic. Companies can borrow money to repurchase shares, or issue new shares after completing share repurchases. Liquidity-based strategies look at three separate criteria: companies that shrink their float over time through buybacks, reverse stock splits, or spinoffs; companies that shrink the float because the business is profitable, not because they are divesting assets; and not investing in companies that simply swap equity for debt.
There are a number of ETFs that invest in companies that buy back their own shares, such as Powershares Buyback Achievers, Trim Tabs Float Shrink, and the Guggenheim Insider ETF.
Today’s screen shows the top 10 positions in the Powershares Buyback Achievers ETF. To be included in this ETF, a company must be incorporated in the U.S., trade on a U.S. exchange, and must have repurchased at least 5 per cent or more of its outstanding shares for the trailing 12 months. The portfolio is balanced quarterly, and reconstituted annually.
What did we find?
U.S. companies are spending more on stock repurchases than on dividends, and free cash flow is growing more rapidly than dividends. The dividend yield on the S&P 500 is about where it was in 2008, yet the free cash flow yield has tripled from 1998. Companies used much of that cash flow to buy back their own shares.
By investing in companies that shrink the float while growing free cash flow, and not increasing their leverage, investors are investing along with the people who possess the best knowledge of their companies.
Michael Bowman is a portfolio manager at Wickham Investment Counsel Inc. in Hamilton.
Top 10 stocks in the Powershares Buyback Achievers ETF
|Company||Ticker||Recent price ($)||Yield (%)|
|Walt Disney Co.||DIS-N||47.80||1.27|
|Home Depot Inc.||HD-N||52.81||2.23|
|Time Warner Inc.||TWX-N||37.28||2.79|
|Lowes Co. Inc.||LOW-N||28.68||2.24|
All dollar figures U.S. Source: Wickham Investment Counsel
|Company||Ticker||Recent price ($)||Yield (%)||P/E||Weight|
|Walt Disney Co.||DIS-N||47.80||1.27||17.1||4.51|
|Home Depot Inc.||HD-N||52.81||2.23||20.1||4.08|
|Time Warner Inc.||TWX-N||37.28||2.79||13.7||1.97|
|Lowes Co. Inc.||LOW-N||28.68||2.24||16.3||1.84|