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When Suncor Energy Inc. announced earlier this month its intention to buy back more than $2-billion worth of its own shares, some investors were no doubt perplexed: With the share price approaching a 10-year high after a 45-per-cent rally since July, surely management is demonstrating awful market timing.

If Suncor is buying high, should investors sell?

The question often arises with buybacks, where companies repurchase their own shares over a specified period of time.

Buybacks are not investments. They reduce the number of outstanding shares – about 3 per cent, in the case of Suncor − which means that profits are spread less widely. All else being equal, earnings-per-share will rise, which can lift the share price if the stock’s price-to-earnings ratio stays constant.

In effect, buybacks are akin to dividends, in the sense that both use cash to reward shareholders.

But buyback activity has a contrarian reputation: Activity tends to decline during bear markets when stocks are cheap, and rise during bull markets when stocks are expensive. Better to sell shares when companies are buying, the contrarian thinking goes.

After all, corporate buyback activity last peaked in 2007, prior to the financial crisis. Following a lull during the depths of the bear market, buybacks are again nearing record highs. Companies in the S&P 500 spent a total of US$519-billion on buybacks in 2017, according to S&P Dow Jones Indices.

S&P 500 DIVIDENDS and BUYBACKS

In billions of U.S. dollars, annualized

$3,000

2,750

April

Buybacks

2,500

Dividends

2,250

S&P 500 Index

2,000

1,750

1,500

1,250

1,000

Q4

750

500

Q1

250

0

‘99

‘01

‘03

‘05

‘07

‘09

‘11

‘13

‘15

‘17

‘19

THE GLOBE AND MAIL, SOURCE: yardeni research

(data via standard & poors)

S&P 500 DIVIDENDS and BUYBACKS

In billions of U.S. dollars, annualized

$3,000

2,750

April

Buybacks

2,500

Dividends

2,250

S&P 500 Index

2,000

1,750

1,500

1,250

1,000

Q4

750

500

Q1

250

0

‘99

‘01

‘03

‘05

‘07

‘09

‘11

‘13

‘15

‘17

‘19

THE GLOBE AND MAIL, SOURCE: yardeni research

(data via standard & poors)

S&P 500 DIVIDENDS and BUYBACKS

In billions of U.S. dollars, annualized

$3,000

2,750

April

Buybacks

2,500

Dividends

2,250

S&P 500 Index

2,000

1,750

1,500

1,250

1,000

Q4

Q4

750

500

Q1

Q1

250

0

‘99

‘01

‘03

‘05

‘07

‘09

‘11

‘13

‘15

‘17

‘19

THE GLOBE AND MAIL, SOURCE: yardeni research (data via standard & poors)

It may be tempting to follow this contrarian logic in the case of Suncor, an economically sensitive stock whose fortunes rise and fall with the price of oil. But the better bet is to recognize that the oil producer’s managers are probably making the right move.

Why? First of all, buybacks tend to be rewarded by the market.

The S&P 500 buyback index tracks the 100 stocks in the S&P 500 with the highest level of buyback activity relative to outstanding shares. The buyback index has outperformed the S&P 500 by eight percentage points over the past five years and 2.7 percentage points over the past year (including dividends).

This is an indication that investors like buybacks, or that companies that initiate buybacks tend to be in better shape than the broader market.

Suncor is certainly in good shape. Its funds from operations increased to nearly $2.2-billion in the first quarter, up 7 per cent year-over-year. And its debt relative to cash flow is already low relative to its Canadian peers, according to RBC Dominion Securities.

Second, buybacks look good when you consider the alternatives.

Companies can divert money toward dividends, rewarding investors with actual cash. But higher quarterly payouts tend to be seen by the market as a permanent feature, and therefore aren’t always the right move for companies that want to maintain financial flexibility.

Unlike dividends, buybacks can come and go without a market reaction. And besides, Suncor has been raising its quarterly dividend as well, most recently in March, when it increased its quarterly payout by 12.5 per cent to 36 cents a share.

The buyback announced this month, then, is a bonus – and more tax efficient than a regular dividend or a one-time special payout.

And third, Suncor’s management could find something else to do with the $2.2-billion now earmarked for buybacks, but the ideas might not be an effective use of capital.

It could buy acquire another company. But the prices of most energy assets have been on the rise with climbing oil prices and the global economic expansion, tracking Suncor’s own rising share price. If a deal were struck, critics would still believe Suncor was buying high.

And finally, consider that Suncor’s managers aren’t trying to time the stock’s highs and lows. Indeed, the buyback may signal that managers believe they are no better at market timing than the rest of us. And they’re probably right.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 24/05/24 7:00pm EDT.

SymbolName% changeLast
SU-N
Suncor Energy Inc
+0.45%40.3
SU-T
Suncor Energy Inc
+0.4%55.28

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