There isn’t always good news for the U.S. market as a whole in the recent rise in stock buybacks. Birinyi Associates says that May was a “record-setting month for announced buybacks” and that “2024 is the second-highest ever in the number of [buyback] announcements as well as the value of announcements.” That’s too bad.
In general, companies are bad at timing the market, so they tend to buy back shares when prices are high. This is why you should not join the buyback party. Even Apple AAPL, 1.41%, which made more than half of May’s record-setting total, isn’t very good at predicting the market.
The huge buyback by Apple
In May, the most buyback announcements ever. A big reason for this was Apple’s announcement of a $110 billion stock repurchase program, which Birinyi Associates calls the “largest single program announcement on record.” Apple has spent more than $800 billion on buybacks since it started doing them in 2012.
Because Apple plays such a big role, I looked at its track record as a market timer when it comes to repurchases. The chart above shows what I found in brief. It focuses on both the quarters since 2012 when Apple spent more than usual on buybacks and the quarters when it spent less than usual.
When Apple bought back shares above average, the company’s average total return was lower than when it bought back shares below average. In other words, not great market timing. The differences in the chart are not significant at the 95% confidence level that statisticians use to see if a pattern is real. This is because Apple’s quarterly returns vary a long way.
What happened and why
What financial historian and investment strategist Edward Chancellor calls the “capital cycle” is what makes it so hard to time the market right. He says in his book “Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002–15” that when the cycle is going up, companies become too confident and “capital discipline” is loosened because they are making a lot of money. M&A activity, IPOs, and secondary offerings all go up, as well as the number of buybacks.
The chart above shows how this strongly procyclical behavior looks. It shows how many S&P 500 SPX stocks are bought back, as well as how many mergers and acquisitions and initial public offerings happen around the world. What goes up must come down at some point, as shown by the chart. Chancellor says that when “profits collapse,” capital expenditure “is slashed.” This is why all three series generally go down at the same time.
In an email, William Bernstein of EfficientFrontier.com summed up this point of view: “Companies buy back shares when the sky is blue and they have a lot of extra cash; when the sky turns dark and the best deals can be had, they hoard cash.”
Growth vs. value
One way to understand this is to look at how often buybacks happen in growth stocks and value stocks. People who own value stocks are near or at the bottom of Chancellor’s capital cycle. People who own growth stocks are near or at the top. As it turns out, new research shows that growth stocks buy back more of their own shares than value stocks.
The study, called “How Do Managers Expectations Affect Share Repurchases?,” was written by an Australian professor named Minsu Ko. The chart below shows what he found. It shows 10 groups of stocks arranged by their price-to-book ratios. In the past, growth stocks were thought to have high ratios like this, while value stocks were thought to have low ratios.
Notice the perfect correlation: The decile of stocks with the highest price/book ratios — those at the extreme “growth” end of the value-growth spectrum — also had the most buybacks. At the opposite end of the spectrum, the decile of stocks with the lowest price/book ratios, had the lowest buyback volume.
Ko found that a different definition makes corporations look to be not as terrible at market timing. This alternate definition is the degree to which management’s internal earnings expectation diverges from the Wall Street consensus. Ko found companies repurchase more of their shares to the extent their earnings expectation is further above the consensus — and vice versa.
Bernstein is skeptical that Ko’s results mean that corporations are decent market timers when executing their repurchases, however. He says: “Another interpretation… is that insiders execute buybacks so that they can engineer/manipulate earnings to juice the stock price.”
Net versus gross buybacks
Clouding the picture is that corporations on occasion execute buybacks for reasons other than wanting to reduce shares outstanding and thereby increase earnings per share. For example, they often buy back shares in order to facilitate management’s desire to exercise stock options and sell the resultant shares of stock. Robert Arnott, founder and chairman of Research Affiliates, pointed out in an email that in such cases management actually has an incentive to be a bad market timer, since it wants to buy back shares at the highest possible price — when their options will be most valuable.
Many researchers therefore focus instead on net- rather than gross buybacks: total number of shares repurchased less the number of shares the company has issued. To investigate the market timing significance of net buybacks, I measured the correlation of net buybacks over the trailing five years with the S&P 500’s performance over the subsequent five years. I extended my analysis back to the early 1990s, which is when buybacks began playing a dominant role in the market.
I found that the correlation is negative. That is, higher net buyback was
followed by lower subsequent stock market returns, and vice versa. The
correlation is significant at the 95% confidence level that statisticians often use when determining if a pattern is genuine. The recent surge in market-wide buyback activity might therefore mean that we’re closer to a market top than a market bottom.
