Fund Selector: Indulging in a buyback binge
In 1984 Warren Buffet was quoted as saying when strong companies see their shares trading far below their intrinsic value, “no alternative action can benefit shareholders as surely as repurchases”.
During the calendar year of 2013, the S&P constituents collectively bought back $500bn (£330bn) of their own stocks – close to the highs of 2007. This accounted for an incredible 33 per cent of total cashflow and represented 60 per cent of cash returns to shareholders – overshadowing dividend returns.
It is not just a US phenomenon. Across Europe and pan-Asian markets, companies are turning to aggressive buyback policies to enhance return on equity.
In fact, companies on Japan’s Topix index are buying back shares at their fastest rate ever, which is perhaps less surprising, given that one aspect of prime minister Shinzo Abe’s economic policies is to improve the reputation of corporate Japan.
Additionally, foreign investors now account for a record 31 per cent of all Japanese stock, suggesting western corporate cultures are being imposed on, and accepted by, Japanese companies.
Many companies across the globe have sat on record cash piles in the face of economic uncertainty, thus protecting balance sheets but diluting earnings per share, so in many ways a buyback policy can be interpreted as a victory for shareholders.
Even Apple, with the largest cash mountain of any firm in the world, has initiated a buyback policy worth $130bn over three years.
However, history tells us that management is rather poor at timing buybacks. A record year for companies buying their own stocks was 2007, just ahead of the financial crash, while 2009, at the nadir of the market, was a thin time for buybacks.
In fact, in the six months to May 2008, Lehman Brothers spent $1bn on buying its shares and the financial sector in the US spent $207bn between 2006 and 2008 on the same strategy.
Then 2009 witnessed taxpayers pumping $250bn back in the market to prop them up.
A cynic may also suggest there is a temptation to return too much cash, damaging balance sheets and restricting growth opportunities, due to the short-term ‘sugar rush’ impact a buyback can have on a share price in a world that demands immediate results.
Although when one looks at the Japanese corporate cycle in the early 1990s, and the mismanagement of balance sheets and excessive investment, which in part led to the collapse of corporate Japan, one would perhaps be encouraged by the current buyback vogue.
Not all company managements can be accused of balance sheet engineering to propel share prices – Simon Henry, the chief financial officer at Royal Dutch Shell, acknowledged that a compromise needs to be found to ensure sustainability.
“The longevity of the firm is what matters… executives need to hold their nerve against short-term pressure so that they can invest for the long run,” Mr Henry has been quoted as saying.
Ultimately, shareholders are likely to drive policy, and no doubt the cycle will shift again in time from increasing short-term return on equity to investment and merger and acquisitions.
James Sullivan is investment director and senior fund manager at Coram Asset Management
