Is The Buyback Tide Turning?

4/4/2016


Companies remain infatuated with their own shares, though investors may have lost that loving feeling. After all, stock repurchases serve many purposes, not all beneficial to investors.

• Stock buybacks benefit investors if the repurchased shares are undervalued. Then there are companies like IBM ($148; IBM), which spent $59.13 billion over the past five years to slash its share count by 23%. IBM paid an average of $182 per share — a 23% premium to its current stock price — leaving investors to wonder how else that cash could have been deployed.

• Buybacks augment per-share-profit growth in a sluggish economy. However, such growth can come at the cost of neglecting capital investment required to grow the business.

• By boosting demand for shares, buybacks can stabilize the stock price in volatile markets. However, the shares may become vulnerable to a sell-off when management suspends buyback activity for blackout periods during earnings season — or any other time it wishes to stop the repurchases.

• Finally, companies often repurchase shares to offset dilution caused by stock awards, obscuring the true cost of executive compensation.

With those four points in mind, investors may be losing enthusiasm for companies that devote significant resources to repurchasing shares. The S&P 500 Buyback Index, which tracks the S&P 500 Index companies most aggressively buying back stock, has fallen 7% in the past year, lagging the S&P 500 Index's flat return.

Recent weakness reverses a longstanding trend — the buyback index has surged 122% since February 2006, doubling the broader index's return. About two-thirds of the buyback index's market capitalization is concentrated in three sectors — consumer discretionary, industrials, and technology.

Buyback activity has risen in three straight years as it approaches the record high set in 2007. S&P 500 companies repurchased $572.16 billion in stock last year, up 3% from 2014; buybacks reached $589.11 billion in 2007.

Dividends tend to be far less volatile than stock buybacks from quarter to quarter. S&P 500 dividends eclipsed prerecession levels in the June 2012 quarter and have risen year-over-year in 23 straight quarters.

Many companies have loaded up on cheap debt in recent years in order to ramp stock repurchases. Rising interest rates will increase corporate borrowing costs, which could slow the pace of future buybacks. Nevertheless, Goldman Sachs ($157; GS) forecasts S&P 500 companies will spend a record $608 billion on buybacks this year, while dividend payments could reach $432 billion, up from $382.46 billion in 2015. Together, buybacks and dividends are expected to account for 46% of corporate spending this year, up from 39% last year.

A total of 283 stocks in the S&P 500 lowered their share count at least 1% in the past year, while 93 companies reduced outstanding shares by 5% or more. The A-rated stocks in the table below all lowered their share counts by at least 5%. Encouragingly, their shares also appear cheap, given that they score above 60 for Quadrix Value. We review some of our favorite stocks from that group below:

Alaska Air Group's ($82; ALK) free cash flow surged to $651 million last year from $268 million in 2014. Rising cash flow has funded the airline's capital returns to shareholders. Alaska Air used stock repurchases to cut its share count more than 5% last year, paying an average price of about $70 per share. Stock buybacks have slashed Alaska Air's share count by 14% in the past five years. It has repurchased 35% of outstanding shares since 2007.

Management expects cash flow to remain "very strong" in 2016, while capital expenditures should decline to about $795 million from the $831 million spent last year. Both trends should help Alaska Air return more cash to investors than it did last year. The company has already hiked its quarterly dividend 38% this year, and it has $880 million remaining on its current stock-buyback plan, equating to nearly 9% of outstanding shares. Alaska Air is a Focus List Buy and a Long-Term Buy.


Biogen ($254; BIIB) has repurchased 36% of its outstanding shares in the past decade, including a nearly 7% reduction in 2015. Biogen exhausted its $5 billion stock-buyback program at the end of 2015 and has yet to announce a new plan. In January, Biogen suggested it may deploy more cash on strategic initiatives, such as acquiring development rights for experimental drugs.  Management also expects capital spending to climb 24% to 32% this year as the company builds a new manufacturing facility in Switzerland for biological drugs.

Management's 2016 per-share-profit guidance of $18.30 to $18.60 implies 8% to 9% growth and assumes the share count will remain flat. So if Biogen does proceed with more stock buybacks, there is upside potential to its guidance. The consensus estimate stands at $18.60. At 14 times estimated year-ahead earnings, the stock trades 39% below the median for S&P 1500 biotechnology stocks. Biogen is a Buy and a Long-Term Buy.


Since launching its share-repurchase program in 2011, Lear ($112; LEA) has lowered its share count 34%. The buybacks look like a good deal for investors, considering Lear has paid an average share price of $68. In February, Lear increased its buyback plan to $1 billion from the $513 million that remained at the end of 2015. The buyback plan will run through 2017. Management also hiked its quarterly dividend 20% earlier this year.

The stock still looks cheap, earning a Value rank of 92 and trading at just 10 times trailing earnings, a 32% discount to the median for S&P 1500 auto-parts suppliers. Lear ranks among the cheapest 20% of stocks in our research universe based on trailing P/E, forward P/E, enterprise ratio, and price/sales ratio. Lear is a Focus List Buy and a Long-Term Buy.


2016 buyback plans on record pace

U.S. companies announced stock-buyback programs totaling $158 billion in the first two months of 2016, according to Birinyi Associates, the strongest start to a year since at least 1984.

Recommended stocks that have announced new buyback programs in 2016 include:

• Comcast ($61; CMCSa) increased its stock-repurchase plan to $10 billion, with half expected to be spent this year.

• Gilead Sciences ($92; GILD) said it will launch a fresh $12 billion buyback plan upon completion of its current program, which had $8 billion remaining at the end of 2015. Gilead spent more than $10 billion on buybacks last year, and in February the company said it planned to repurchase $5 billion in stock over the next three months.

• Kroger ($38; KR) disclosed a new $500 million buyback program, in addition to the $176 million remaining on its prior plan. 

• J.P. Morgan Chase ($60; JPM) won approval from the Federal Reserve to buy back an additional $1.88 billion in shares through June.            

• Lear ($112; LEA) boosted its stock-repurchase plan to $1 billion.

• Wells Fargo ($49; WFC) increased its buyback plan by 350 million shares, equating to roughly $17 billion at current prices.

Comcast, Gilead, and Lear are Focus List Buys and Long-Term Buys. Kroger is a Buy and a Long-Term Buy. J.P. Morgan and Wells Fargo are rated Long-Term Buy.

SHRINKING THE SHARE COUNT
The A-rated stocks listed below reduced outstanding shares at least 5% in the past year. All 11 companies aggressively repurchased their own stock over the last year and boast shareholder yields of at least 5%. Shareholder yield equals dividends and share repurchases divided by stock-market value. Stocks on our buy lists are in bold.
12-Month
--- Spending On ---
12-Month Share
---- Repurchases ----
Total
--- Return ---
----- Quadrix Scores -----
Company
(Price; Ticker)
Divs.
($Mil.)
Stock
Buybacks
($Mil.)
Div.
Yield
(%)
Share-
holder
Yield
(%)
Share-
Count
Change
(%)
No. Of
Shares
Repurchased
(Millions)
YTD
(%)
1
Year
(%)
Value
Perfor-
mance
Overall
Sector
Alaska Air
($82; ALK)
102
504
1.3
5.8
(5)
7
3
26
80
65
99
Industrials
American Express
($60; AXP)
1,172
4,599
1.9
9.8
(5)
60
(13)
(22)
91
20
85
Financials
Applied Materials
($21; AMAT)
480
1,950
1.9
10.0
(7)
112
13
(6)
60
85
92
Technology
Biogen
($254; BIIB)
0
5,000
0.0
8.9
(7)
17
(17)
(41)
74
15
91
Health care
Express Scripts
($69; ESRX)
0
4,672
0.0
9.9
(7)
55
(21)
(19)
92
17
90
Health care
F5 Networks
($105; FFIV)
0
657
0.0
8.9
(5)
6
9
(8)
71
55
86
Technology
Gilead Sciences
($92; GILD)
1,874
10,337
1.9
9.0
(8)
99
(9)
(7)
95
24
100
Health care
Lear ($112; LEA)
79
487
1.1
6.6
(5)
4
(9)
1
92
50
96
Cons.
discretion.
Time Warner
($72; TWX)
1,150
3,599
2.2
8.1
(5)
45
12
(14)
72
58
87
Cons.
discretion.
Travelers
($117; TRV)
739
3,224
2.1
11.1
(8)
30
5
10
80
81
89
Financials
Valero Energy
($64; VLO)
848
2,838
3.8
12.0
(8)
45
(9)
3
91
56
76
Energy
Note: Quadrix scores are percentile ranks, with 100 the best.  NA Not available. 

 


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