Canadian companies have been enthusiastic buyers of their own shares at a time when Warren Buffett – the world's greatest investor – continues to rail against buybacks. Should investors be worried?
Buybacks, or share repurchases, are a way for companies to return money to shareholders without committing to dividend hikes. The practice reduces the number of outstanding shares, boosting profit on a per-share basis by at least 4 per cent, according to Standard & Poor's recently quarterly figures.
Put another way, buybacks give existing investors a bigger share of the haul, often with the effect of lifting the share price.
Toronto-Dominion Bank announced on Thursday its intention to buy back up to 15 million shares, or 0.8 per cent of its outstanding float, returning $1-billion to shareholders based on the current share price. Bank of Montreal announced earlier in the week it would buy back up to 2.3 per cent of its outstanding shares valued at a potential $1.5-billion.
The other big banks have been active with their own buyback plans, along with the likes of other large Canadian companies including Canadian Tire Corp. Ltd., Canadian National Railway Co. and Canadian Pacific Railway Ltd., according to LuxArbor Institutional Positioning, a Montreal-based firm that tracks institutional positioning in financial markets.
Mr. Buffett, however, believes most buybacks tend to squander precious capital. In his much-anticipated annual letter, released last Saturday, he said "repurchases only make sense if the shares are bought at a price below intrinsic value."
He added: "Before even discussing repurchases, a CEO and his or her board should stand, join hands and in unison declare, 'What is smart at one price is stupid at another.'"
Mr. Buffett practises what he preaches. His company, Berkshire Hathaway Inc., buys its own shares only when they trade below 1.2 times book value – a threshold that, in recent years, has proved to be a good buying opportunity.
But investors might want to take a more relaxed approach – yes, even if that means questioning the logic of the Oracle of Omaha – and accept buybacks as a nice bonus rather than a waste of money.
For one thing, investors – not companies – tend to determine whether a stock is under- or overvalued. Companies should be relatively agnostic about their share price, announcing buybacks when they have excess cash.
If a company only buys back its shares when it feels they are undervalued, wouldn't the company be signalling its shares are pricey when it doesn't announce a buyback?
Second, companies have other ways of spending their money, and mergers and acquisitions activity is a popular one. But a number of academics, including Aswath Damodaran, a professor at the Stern School of Business at New York University, believes acquirers tend to destroy more value than they create.
Buybacks, then, offer a safer alternative for companies with excess cash. In fact, repurchasing shares can suggest a company is showing restraint relative to peers who might be making risky acquisitions at outrageous prices.
Lastly, buyback activity may not be the contrarian indicator it was several years ago.
According to FactSet Research Systems, a financial-analysis firm, buybacks among companies in the S&P 500 peaked at a quarterly high of nearly $170-billion (U.S.) in the fourth quarter of 2007. This was when stock prices were near record highs prior to the onset of the Great Recession.
Buyback activity subsequently bottomed out in 2009, after the S&P 500 had fallen about 50 per cent during the bear market – which suggests investors should feel bearish when buyback activity is high and bullish when activity is low. But wait a minute: Buyback activity, although still popular, has fallen from its recent highs while the stock market continues its rise.
According to FactSet, U.S. buybacks for companies in the S&P 500 totalled about $160-billion in the second quarter of 2016. Buybacks have since declined for two straight quarters, to about $116-billion in the fourth quarter of 2016, even as the S&P 500 is about 16 per cent higher than it was in mid-2016. As well, the number of companies participating in buybacks is near a five-year low.
Similarly, LuxArbor showed Canadian buybacks in the third quarter of 2015 totalled about $10-billion (Canadian). They fell to about $7-billion in the fourth quarter of 2016 – as the S&P/TSX composite index marched higher.