StockWatch
Buybacks are Bullish
Companies buying back their shares in the open market is not a new phenomenon, of course.
But, it sure seems as though there’s been a lot of it lately. And, it carries potentially bullish long-term consequences.
In early July, for example, Johnson & Johnson announced that its Board of Directors had authorized the repurchase of up to 10 billion dollars of its common stock.
That’s billion with a “b”.
ConocoPhillips announced that its Board had approved an even larger buyback program, involving as much as 15 billion dollars of its shares.
These announcements are good news because the average company that repurchases its shares outperforms the market by an annualized average of 3.1 percent over the four years following the announcement of its share repurchase program. That’s the finding of perhaps the most comprehensive academic study of repurchase programs, which appeared in the Journal of Financial Economics.
Why would repurchases carry such bullish potential? One theory explains it in terms of simple supply and demand: Repurchases reduce the supply of a company’s outstanding stock, which, according to Economics 101, should increase the price of the remaining shares.
Another theory: Companies that repurchase their shares are so confident about their future prospects that they are willing to commit corporate resources to buy shares. This is worth paying attention to because a company’s executives and Board of Directors have access to insider information that the rest of us do not.
In this way, at least, repurchase programs are analogous to corporate insiders purchasing their companies’ shares for their own accounts. Both phenomena signal confidence in the company’s future prospects. The difference, of course, is that, in the one case, the insiders are spending their own money; whereas, in the other, they are spending the company’s cash.
To be sure, insiders don’t always do the same thing with their own money as they do with their companies’ cash. So, when interpreting a firm’s repurchase announcement, it’s important to take a look at how its insiders have been behaving.
One service that keeps track of whether a company’s insiders are behaving bullishly or bearishly is the Vickers Weekly Insider Report, published by Argus Research. Each week, Vickers calculates an index that “rates each company’s insider transactions for the past six months, taking into account numerous factors that are weighted according to relative importance. Factors include, but are not limited to, the number of buy and sell transactions recorded for each company, the percentage changes that occur in an insider’s holdings with each transaction, unanimity among insiders at a given company, the dollar value of a transaction, and reversals in transaction patterns (from buying to selling or vice versa).”
A positive insider index value means that Vickers’ algorithm considers the behavior of a company’s insiders to be bullish on balance while negative values mean just the opposite. According to the Vickers Weekly Insider Report that was received in the week prior to these companies’ buyback announcements, the Vickers insider index for Johnson & Johnson was 10 while, for ConocoPhillips, it was minus 22.
How can you make sense of these conflicting signals? One solution might be to subscribe to an investment newsletter that focuses on companies’ repurchase programs. It is The Buyback Letter, edited by David Fried. Before recommending a company that has announced a share repurchase program, however, Fried takes a number of other factors into account -- such as whether its insiders are buying or selling for their own portfolios.
The Hulbert Financial Digest has been tracking The Buyback Letter since the beginning of 1997. Since then (through this past June 30), its several model portfolios have produced an average annualized gain of 16.4 percent, versus 9.0 percent for the Dow Jones Wilshire 5000 index. Better yet, this market-beating gain was produced with slightly less volatility, or risk.
Mark can be contacted via email at mhulbert@marketwatch.com.
