Over the past few years at StreetAuthority, we’ve been chronicling the remarkable pace of share buybacks. So many companies are buying back $500 million or even $1 billion in stock that this trend has become one of the most powerful themes of the current investing era.
The collective result of all of those individual corporate actions is simply staggering. Analysts at J.P. Morgan report that a hefty $455 billion in shares has been reacquired by companies in the Russell 1000 in the 12 months ended June 30. That’s a 32% increase from the prior 12-month period.
In fact, if you go back to the start of 2009, companies have reacquired $1.4 trillion of their stock. That “far exceeds the net equity withdrawals by investors,” noted J.P. Morgan’s analysts. In effect, these analysts have concluded that in the absence of buybacks, this stunning market rally would never have existed.
What can you expect in the years ahead? Many more buybacks. Companies remain loath to pursue acquisitions, even with huge amounts of cash parked on their balance sheets. So an increasing amount of annual cash flow is heading towards buybacks (and dividends).
Yet with the major market averages now up so sharply since the start of 2009, should investors look at buybacks as a wise use of corporate capital? The sage response: You can’t time the market. The market tends to rise over time, and if companies wait for the moment that their stock pulls back sharply to lower levels… well, that day may never arrive.
As noted, JP Morgan analysts suggest that the sharply reduced amount of shares trading hands explains this bull market. After all, share prices are affected by supply and demand, and a reduced supply of stock pushes up prices, according to economic theory.
Yet there’s another, more obvious reason why buybacks boost share prices: the impact on earnings per share (EPS). The percentage of shares that are being bought back will boost per share profits by that exact same percentage (offsetting stock option grants notwithstanding). Simply put, a steady series of buybacks can help a slow-growing company deliver the kind of EPS growth that is usually reserved for faster-growing companies.
Take do-it-yourself home retailer The Home Depot, Inc. (NYSE:HD) as an example. Since 2004, its shares count has fallen more than 30%, to 1.5 billion. The company earned $3.10 a share in its fiscal 2013 — but were it not for that massive stock buyback program, per-share profits would have been 30% lower.
We periodically highlight companies that are pursuing massive stock buybacks, most recently last month.
But there is an even more direct way to benefit from the trend: buyback-focused exchange-traded funds (ETFs). Let’s take a closer look.
1. PowerShare Buyback Achievers Fund (ETF) (NYSEARCA:PKW)
This fund is quite picky, loading up only on shares of companies that have already purchased at least 5% of their shares outstanding over the past 12 months. The approach is a bit curious.You would presume that the best time to buy a stock is when a buyback is announced, not after a program has been underway for quite some time. This approach stems from the fact that many companies announce huge buybacks plans — but tend to use them to offset lavish grants of stock options to executives. By waiting for confirmation of a reduced share count, the risk of a smoke-and-mirrors buyback announcement is eliminated.
Current top holdings include Amgen, Inc. (NASDAQ:AMGN), ConocoPhillips (NYSE:COP) and Oracle Corporation (NASDAQ:ORCL), each of which accounts for roughly 5% of the portfolio. The fact that fully one-third of the portfolio is made up of consumer discretionary stocks highlights the robust pace of buybacks in that sector. (Financials make up another 20% and tech stocks make up another 16%.)