If buyback activity were a bullish omen, then the stock market’s bulls would have reason to be dancing in the streets.
That’s because corporations are repurchasing their shares at a blistering and accelerating pace. In this year’s second quarter, for example, announced new buyback programs amounted to more than $430 billion. That broke the previous record for quarterly buyback announcements that was set in the first quarter of 2018, which was just over $240 billion.
You will notice that this new quarterly record was nearly double that previous one. Corporations aren’t just gradually ramping up their repurchases; they’re falling over themselves to do so.
But is total buyback activity a good stock market indicator? In the 1980s and 1990s, at least, it was. In those decades, a number of academic studies found, the stock of the average company that announced a new buyback company proceeded to significantly outperform the market over several years following that announcement.
Since then, the situation has changed. One recent study, for example, found no outperformance from buyback activity over the decade through 2012 — that the stock of the average company announcing a buyback performed no better than the S&P 500 SPX, -0.58% after that repurchase program was announced.
What changed? No doubt a number of factors conspired to bring about the shift. One was that companies increasingly began to substitute share repurchases for dividends when returning cash to shareholders, since the former carries no expectation that they will continue indefinitely while cutting a dividend engenders a negative reaction from the market. As a result, repurchase programs have come to reflect the presence of free cash flow, having nothing to do with whether management believes their company’s shares are undervalued.
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This was the clear finding of a recent study entitled “Share Repurchases, Market Timing and the Distribution of Free Cash Flow,” by Chao Zhuang of the University of Southern California. The author segregated companies in past years into two groups — those whose shares were especially undervalued, and those with a lot of free cash flow (defined as cash above and beyond needed to run the company, pay its dividend, invest in R&D, etc. etc.) He found that companies in the latter group were 12 times more likely to announce a buyback than companies in the former.
Zhuang’s conclusion: “Market-timing opportunities only marginally influence managerial repurchase decisions.”
The question that exuberant bulls therefore should be asking: If market timing and perceived undervaluation have so little to do with a company’s decision to repurchase its shares, why should we think their behavior is bullish?
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