Credit: Shutterstock photoOn page seven of the Berkshire Hathaway 2016 annual report, billionaire CEO Warren Buffett offers his opinion on share buybacks: "My suggestion: Before even discussing repurchases, a CEO and his or her Board should stand, join hands and in unison declare, 'What is smart at one price is stupid at another.'"
While simple math shows that stock repurchases boost earnings-per-share for investors, the move only makes good big-picture sense if the shares are being repurchased at a reasonable price. According to Buffett, this means that shares are bought at a price below intrinsic value: "Ergo, the question of whether a repurchase action is value-enhancing or value-destroying for continuing shareholders is entirely purchase-price dependent."
A recent Barron's article says that, although reducing share count has allowed companies to boost value for shareholders over time, the shine has come off the repurchase penny of late. "As with many games," it says, "this one has gone on for too long, as companies borrowed heaps of cash not to fund future growth, but to reduce their share count even further."
According to data provided in the FactSet Buyback Quarterly, for the third quarter of 2016 (August-October), S&P 500 share buybacks totaled $115.6 billion, representing a year-over-year decrease of 28%. The report says it was the "smallest quarterly buyback total since Q1 2013."
An article in this month's Business Insider cites Bloomberg data showing that a Goldman Sachs basket of stocks with the highest buyback yields has underperformed the S&P 500 by 2.3 percentage points year-to-date. The article says, "This is an enormous turnaround: The same gauge beat the benchmark by more than 100 percentage points from the start of the bull market through 2016."
One reason for the slowdown in repurchases is that share valuations are relatively high. The BI article quotes Goldman's chief equity strategist David Kostin who wrote in recent note to clients, "Experience shows that firms repurchasing shares at extremely high valuations regret those actions when the stock price inevitably de-rates."
In his letter to shareholders, Buffett argues that when management teams consider repurchasing shares, "they all too often seem oblivious to price. Would they behave similarly if they were managing a private company with just a few owners and were evaluating the wisdom of buying out one of them? Of course not."
What's ahead on the buyback front? If President Trump's push for tax reform is successful, profit repatriation by large multi-nationals could provide ample cash for share repurchases. The president's plan, however, remains a bit of a wild card. Further, rising interest rates could discourage companies from taking on debt to effect buybacks. A Barron's article from earlier this month quotes Evercore ISI strategist Dennis DeBusschere on the subject: "At some point you're left with a whole lot of debt and not much to show for it." The article says that companies could face difficulties down the road if they have invested in buybacks "at the expense of real growth."
Using stock screening models I created based on the fundamentals-driven investment strategies of Warren Buffett, Peter Lynch, James O'Shaughnessy and others, I've identified the following high-scoring companies that have been among the most active in share repurchasing. I started using this list and then I ran all of these stocks through the quantitative models on Validea to find the best scoring names based on their valuations, profitability and quality metrics.
Apple Inc. ( AAPL ) , the tech behemoth, earns a perfect score according to our Buffett-inspired investment strategy based on the company's earnings predictability and ability to pay off debt with earnings in less than two years. Average return-on-equity over the last ten years (31.5%) is more than double the minimum required under this model. Our James O'Shaughnessy-based screen likes the company's size (market cap of $799.49 billion) and cash flow-per-share of $10.77. Shares outstanding of 5.26 billion versus the market average of 630 million earns high marks as well.
General Electric Company ( GE ) , the global industrial giant, scores strongly under our O'Shaughnessy-based screening model due to its size (market cap of $241.67 billion) and trailing 12-month sales of $123.50 billion versus the market mean of $21.37 billion. Dividend yield of 3.45% adds appeal. Our Martin Zweig-inspired investment strategy likes the company's price-earnings ratio of 25.71, which is less than three times the market level of 18.0 (a requirement under this model).
Microsoft Corporation ( MSFT ) , the technology company, develops, licenses and supports a range of software products, services and devices, and earns high marks from our O'Shaughnessy-based screen due to its size (market cap of $530.94 billion) and cash flow per share of $3.39 (versus the market mean level of $1.75). Trailing 12-month sales of $87.24 billion are more than 1.5 times the market mean, a requirement under this model. The company also scores well according to our Validea Momentum screen, which likes the stock's price performance (current price of $68.77 is within 15% of the 52-week high of $69.71).
Allergan PLC ( AGN ) is a specialty pharmaceutical company engaged in the development, manufacturing, marketing and distribution of brand name and over-the-counter pharmaceutical products. The company scores well under our Joseph Piotroski-based stock screening model due in part to its book-market ratio (the inverse of the price-book ratio) which, at 0.93, falls within the top 20% of the market (as required). This model also looks for positive operating cash flow to eliminate those companies under financial distress. With operating cash flow of $1.42 billion in the most recent year, AGN passes this test. The company's liquidity is also trending positive with a current ratio of 2.27 in the recent year, up from 1.03 in the prior year.
Citigroup Inc. ( C ) provides consumers, corporations, governments and institutions a range of financial products and services. Under our O'Shaughnessy-based stock screening model, the company earns high marks for its size (market cap of $171.44 billion) and cash flow-per-share of $6.60 (versus the market mean of $1.75). Trailing 12-month sales of $57.87 billion are more than double the market mean, and shares outstanding (2.76 billion) are well in excess of the market average (630 million). Our David Dreman-based investment strategy looks for price-earnings ratios in the bottom 20% of the market. With a PE of 12.47 (based on trailing 12-month earnings), the company passes this test.
At the time of publication, John Reese AAPL, GE, AGN and C
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
