2018 is shaping up to be a record year for stock buybacks
Warren Buffett’s Berkshire Hathaway recently announced that for the first time since 2012, they would be “buying back” their own stock.
In reporting its quarterly results to Wall Street, Berkshire reported almost $1 billion in share buybacks in the third quarter of 2018, the first time Berkshire has made a share repurchase since 2012.
Is the increased activity of Berkshire’s stock buybacks – and buybacks in general – good indicators for Berkshire or the markets? Or predictors of something else?
Buybacks Used to Be Outlawed
Most investors probably don’t realize this, but stock buybacks were illegal until the early 1980s. Up until that time, the Securities and Exchange Commission considered stock buybacks to be a form of stock market manipulation. And in case you forgot, the SEC’s stated mission has been pretty clear since it was founded in 1934:
The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.
Nonetheless, in 1982, the SEC passed a rule creating a legal process for buybacks and companies started doing so in droves.
A Change for Berkshire?
While Berkshire buying back its own shares might be a departure from the norm, most investors weren’t surprised because the company recently changed its criterial for buybacks.
More specifically, Berkshire had its own rules that restricted the company from buying back its stock if its share price was at or above a 20% premium to book value per share.
But this summer, that policy changed and buybacks are now permitted when Buffett and Charlie Munger (Buffett’s long-time partner) "believe that the repurchase price is below Berkshire's intrinsic value, conservatively determined."
Are Buybacks a Good Sign?
Interestingly, there is a ton of debate and a lot of solid research about whether buybacks are good or bad. But rather than try to answer that question, maybe we should just lay out the arguments.
Advocates of buybacks note that since buybacks reduce the number of shares outstanding, this will give each remaining shareholder a bigger share of future company profits, helping stock prices rise. Well, that’s the theory.
According to JP Morgan, since 2000, stocks with higher buyback yields (i.e., spending on buybacks divided by market capitalization):
- Outperformed their rivals by 1.5% during market corrections and
- Outperformed by 2% during recessions.
Critics of buybacks on the other hand suggest that buybacks simply result in corporations giving money to their shareholders instead of investing in something more productive and beneficial to their long-term success.
And there is additional research that counters JP Morgan’s conclusions with conflicting data. For the past 7 years, financial consultancy firm Fortuna has tracked post-buyback stock prices and created a “buyback ROI.” According to their research:
- Over the five years through 2017, the 353 companies that spent significantly on buybacks underperformed the market on average and
- Their median ROI was 13.8% annually, including dividends, while the S&P 500’s return was 15.8%.
Why Is Buffett Buying Back Now?
This one is probably easier to answer. In a nutshell, Berkshire has a huge cash stockpile of over $100 billion and, at the present time, not many opportunities to buy companies at a price that Warren and Charlie are willing to pay. So, buying back their own stock seems like a better option.
Buybacks Are at Record Levels in 2018
According to market research firm Birinyi Associates, there has been close to $10 trillion in stock buyback announcements since 1984. And since 2008, over $6 trillion in buybacks were announced.
But 2018 is shaping up to be a record year. In fact, analysts at Goldman Sachs project that buybacks will surpass $1 trillion this year, up 46% from 2017’s levels and dramatically above 2007’s all-time high of almost $700 billion.
Final Thoughts from a Financial Advisor
No matter the market environment, investors are generally well-served by ignoring short-term noise about buyback announcements and should instead focus on a company’s fundamentals. I look forward to discussing your thoughts and what you make of this year’s record buyback activity.