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March 19, 2015

Anatomy of The Buyback Binge

By Chad Fraser, Investing Daily 
American companies went on a buying spree in February.No, I’m not talking about acquisitions (though those are on the rise, too). I’m talking about share repurchases.

S&P 500 firms announced a record $118 billion of share repurchase authorizations in February, according toGoldman Sachs Group (NYSE: GS). Including January, the first two months of 2015 saw a total of $152 billion of authorizations—also a record.
The strong start follows a year in which S&P 500 companies increased their spending on buybacks by 17.6%, to $564.7 billion, according to just-released figures from FactSet—though the firm did note that repurchases slipped by 4% on a year-over-year basis in the fourth quarter, the first decline since the third quarter of 2012.

In all, S&P 500 companies have spent more than $2 trillion on repurchases since 2009, according to Bloomberg.

The biggest spender in 2014? Apple Inc. (NasdaqGS: AAPL), with $57 billion of repurchases, far eclipsing second-place IBM Corp. (NYSE: IBM), at $13.4 billion.

Buybacks 101Before we go further, let’s take a step back and look at how buybacks work.

Companies have two main ways of returning cash to shareholders: buybacks and dividends. The latter are pretty straightforward: the company pays a fixed amount for each stock held, usually on a quarterly basis.

Under a share buyback, a company purchases a certain number of its own shares. It may do this on the open market or by giving its shareholders the option to tender their stock to the firm, usually at a slight premium to the market price. It then cancels the purchased shares, reducing the total number outstanding and giving each shareholder a larger slice of the company.

Buybacks also increase earnings per share (because total earnings are divided by fewer shares) and tend to increase the value of the remaining shares.

Here are three companies that have rolled out big buyback plans so far in 2015:
  • Home Depot (NYSE: HD) announced an $18-billion share repurchase program with its fiscal 2014 fourth-quarter earnings last month. The company plans to complete these transactions by the end of its 2017 fiscal year. 

    The home-improvement retailer is a frequent buyer of its own stock: since 2002, it has spent more than $53 billion to repurchase and cancel about 1.2 billion shares.
  • PepsiCo (NYSE: PEP) also announced a new share repurchase authorization in February, with its board authorizing $12 billion of buybacks. The new program starts on July 1, 2015, and expires on June 30, 2018, with PepsiCo expecting to make between $4.5 billion and $5.0 billion of repurchases this year.
  • Gilead Sciences (NasdaqGS: GILD) authorized repurchases of up to $15.0 billion of the company’s common stock in early February. That’s in addition to the $3.0 billion the biotech firm still has on its authorization.

    But the recommendation of our Personal Finance advisory didn’t stop there: it also rolled out plans to start paying a $0.43 quarterly dividend in the second quarter of this year. Based on the current price, the stock will yield 1.7%.
3 Things to Keep in Mind When Evaluating Buyback Plans
  • Not all buybacks are carried out as announced: Unlike dividends—which many investors see as a promise—companies can slow or stop buybacks without affecting most investors’ view of the stock. Home Depot, for example, is under no obligation to follow through on its $18-billion buyback plan.

    This flexibility can be beneficial if a company holds off on buybacks to invest in a new growth project, for example, or make a key acquisition. But it’s hard to dispute the argument that dividends impose a certain discipline on management, where buybacks do not.
  • Timing is key: Buyback critics often point to the fact that corporate managers frequently make ill-timed buybacks. An oft-cited example occurred in the third quarter of 2007, when S&P 500 companies spent a record $172 billion on buybacks while the market was near an all-time high. 

    Spending on repurchases then plunged over 85%, to $24 billion, by the second quarter of 2009. During that time, the S&P 500 Index fell 47%. The end result? S&P companies had repurchased more shares when they were expensive and fewer when they were cheap.

    Warren Buffett recently weighed in on this point in his latest letter to Berkshire Hathaway shareholders: “Berkshire’s directors will only authorize repurchases at a price they believe to be well below [Buffett’s italics] intrinsic value. (In our view, that is an essential criterion for repurchases that is often ignored by other managements.)”
  • Delve into the reasons behind the buyback: Some companies buy back shares to offset stock-based compensation, for example. That dilutes the effect of the buyback, because the shares the company takes off the market are simply replaced by the ones it issues to management. Companies may also increase their buyback programs in an effort to boost their share prices and fend off hostile takeovers.
Courtesy Investing Daily (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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