Our friends at Empirical Research Partners have come up with an interesting piece of analysis on whether share buybacks can mark a business out as a good investment. What really caught our eye here on The Value Perspective was that, while the research started out considering aspects of investment timing, which is very much not our thing, it ended up in value territory, which of course very much is.
Empirical originally set out to analyse whether there might be any excess returns to be had from buying into companies on the day they announce they are embarking on a programme of buying back their own shares – a practice that is a lot more widespread in the US than it is in the UK – and, indeed, there did appear to be a short-term performance benefit.
The research started heading in a different direction, however, once the analysts began to chop up the data. First, they found the performance benefit was magnified if the company announcing the buyback programme was in the cheapest 20% of stocks in a market on a free cashflow yield basis. Then they found the benefit was magnified further still if the company was a regular share buyback practitioner.
Essentially there are two reasons for this, the first of which is that investors tend to have low expectations of stocks when they are among the cheapest in the market. As a result, a decision by management to start buying back shares will, on the whole, be taken as a positive statement on the health of their company’s finances.
Furthermore, as we have pointed out in articles such as Morally neutral, your share buyback scheme is only as good as the valuation on which you buy back the shares. If you are buying them back at a cheaper price than they might otherwise be therefore, that has to be a good thing. Combine that with some generally low market expectations and you could be looking at the proverbial double whammy.
That is indeed what Empirical’s research suggests. What began as an analysis of investment timing, ended up – although not actually framed in terms of value – as another nod to the idea that, if the management of cheap companies are in a position to buy back shares, which will depend both on their company’s circumstances and their own discipline, then that does tend to be rewarded by the market.