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Damodaran on buybacks


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Has there ever been an intensive study on the effect of buybacks on its company's long term share performance?  It makes sense that a company's finance board should have the best insights into its own value.  But, after seeing my own company, and many others, buy back shares when I thought they were way expensive makes me think otherwise.  Personally, I think companies don't have great track records for these things. 

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Has there ever been an intensive study on the effect of buybacks on its company's long term share performance?  It makes sense that a company's finance board should have the best insights into its own value.  But, after seeing my own company, and many others, buy back shares when I thought they were way expensive makes me think otherwise.  Personally, I think companies don't have great track records for these things.

 

Worked for a company who was buying back shares at $30-40/sh.  Then the financial crisis hit and shares dropped to $9, at an all company meeting someone asked why they weren't buying back shares.  The CEO stated they thought shares were a good value but wanted to preserve cash.  Shares recover to $40-70 and suddenly the buybacks begin again.

 

They loved to buy at all time highs and do nothing at lows...many companies are like this.

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To people on this board, buybacks are known and understood to be a great benefit to shareholders when the buybacks are done at attractive levels. The issues with all the media commentary on buybacks, and the several research studies on the topic, are that they look at all buybacks. Obviously, not all buybacks are good. If shares are cheap, buybacks are great; if shares are expensive, buybacks are probably not the ideal use of capital.

 

Ultimately, just as with the rest of the markets, most people are not good investors, and they buy high and sell low. With buybacks, you get the exact same dynamics. Smart companies that do it right are few and far between, but that doesn't impact whether or not "buybacks" as a concept are a positive or negative.

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To people on this board, buybacks are known and understood to be a great benefit to shareholders when the buybacks are done at attractive levels. The issues with all the media commentary on buybacks, and the several research studies on the topic, are that they look at all buybacks. Obviously, not all buybacks are good. If shares are cheap, buybacks are great; if shares are expensive, buybacks are probably not the ideal use of capital.

 

Ultimately, just as with the rest of the markets, most people are not good investors, and they buy high and sell low. With buybacks, you get the exact same dynamics. Smart companies that do it right are few and far between, but that doesn't impact whether or not "buybacks" as a concept are a positive or negative.

 

Exactly!!

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Has there ever been an intensive study on the effect of buybacks on its company's long term share performance?  It makes sense that a company's finance board should have the best insights into its own value.  But, after seeing my own company, and many others, buy back shares when I thought they were way expensive makes me think otherwise.  Personally, I think companies don't have great track records for these things.

 

Worked for a company who was buying back shares at $30-40/sh.  Then the financial crisis hit and shares dropped to $9, at an all company meeting someone asked why they weren't buying back shares.  The CEO stated they thought shares were a good value but wanted to preserve cash.  Shares recover to $40-70 and suddenly the buybacks begin again.

 

They loved to buy at all time highs and do nothing at lows...many companies are like this.

 

Yep.  This is why I have a lot of contention with that article.  I thought it was a bit non-sensical.  I've never seen buy backs done at valuations that make sense.  They just re-affirm my view that the guys driving these things are morons.  Sometimes, I see buy backs when the company shares are drastically under performing the markets.  Dell comes to mind.  And, going private is just a affirmation that they really believe they are being undervalued by the market.  I've seen that happen a few times before in companies I believed were truly undervalued (a small REIT I owned back in 2000 comes to mind).  But, for the most part, I've seen buy backs done that just didn't make sense.  And, I believe if we looked at short term and longer term performance, the markets will probably agree.  At least that is from my own experiences seeing these things. 

 

BUT, I would still love to see a rigorous study done on buy backs and share performance.  I think I've read an article on it once a long time ago, and I remember not being impressed by it.  I mean, if I was, I would be looking for good companies announcing large buy backs and using that as a strategy.  For some reason, I am not.  So, that tells me I haven't read anything so convincing to lead me to believe these are ultimately great things to the shareholder.

 

Personally, I would rather take a dividend versus a buy back.  But, better than either, a buy out at a set target price that is at a premium.

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if you own a stock and rather get dividends, it means your holding a overvalued stock. You should look at that first.

 

If you do a study on the effectiveness on buybacks you are essentially doing a study on capital allocation skills of managers. And I can predict the outcome, the bad ones will underperform, and the great ones outerperform! And companies with very volatile stock prices that generate a lot of cash will benefit the most. But very few managers fully utilize the market swings to maximize returns to shareholders unfortunately. It is no coincidence that almost all the outsiders in thorndike's book did buybacks at the right time.

 

This is really simple, yet for some reason very misunderstood. People can't seem to grasp cheapness of a stock. Oddball's example perfectly illustrates that. The bad allocators are basicly sheep and dont have this inner voice of logic that dictates to do the right thing. They are swayed by the crowd. They say they base their decision on rational constructs, but are really just sheep.

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BUT, I would still love to see a rigorous study done on buy backs and share performance.  I think I've read an article on it once a long time ago, and I remember not being impressed by it.  I mean, if I was, I would be looking for good companies announcing large buy backs and using that as a strategy.  For some reason, I am not.  So, that tells me I haven't read anything so convincing to lead me to believe these are ultimately great things to the shareholder.

 

http://www.amazon.com/Shareholder-Yield-Approach-Dividend-Investing-ebook/dp/B00CRLSL4W

 

I think the evidence is pretty clear that most managers are not good at timing buybacks. But then again, their other capital allocation skills are pretty awful too.

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if you own a stock and rather get dividends, it means your holding a overvalued stock. You should look at that first.

 

If you do a study on the effectiveness on buybacks you are essentially doing a study on capital allocation skills of managers. And I can predict the outcome, the bad ones will underperform, and the great ones outerperform! And companies with very volatile stock prices that generate a lot of cash will benefit the most. But very few managers fully utilize the market swings to maximize returns to shareholders unfortunately. It is no coincidence that almost all the outsiders in thorndike's book did buybacks at the right time.

 

This is really simple, yet for some reason very misunderstood. People can't seem to grasp cheapness of a stock. Oddball's example perfectly illustrates that. The bad allocators are basicly sheep and dont have this inner voice of logic that dictates to do the right thing. They are swayed by the crowd. They say they base their decision on rational constructs, but are really just sheep.

 

I like dividends because I don't need to pay a commission to sell any shares.  Some of my holdings are very illiquid and a dividend puts real cash in my pocket rather than sitting on the ask for months.

 

Some of my holdings are in IRA's so dividends are tax-free for me in there as well, not that I let the tax-tail wag the dog..

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Has there ever been an intensive study on the effect of buybacks on its company's long term share performance?  It makes sense that a company's finance board should have the best insights into its own value.  But, after seeing my own company, and many others, buy back shares when I thought they were way expensive makes me think otherwise.  Personally, I think companies don't have great track records for these things.

 

Worked for a company who was buying back shares at $30-40/sh.  Then the financial crisis hit and shares dropped to $9, at an all company meeting someone asked why they weren't buying back shares.  The CEO stated they thought shares were a good value but wanted to preserve cash.  Shares recover to $40-70 and suddenly the buybacks begin again.

 

They loved to buy at all time highs and do nothing at lows...many companies are like this.

 

Yep.  This is why I have a lot of contention with that article.  I thought it was a bit non-sensical.  I've never seen buy backs done at valuations that make sense.  They just re-affirm my view that the guys driving these things are morons.  Sometimes, I see buy backs when the company shares are drastically under performing the markets.  Dell comes to mind.  And, going private is just a affirmation that they really believe they are being undervalued by the market.  I've seen that happen a few times before in companies I believed were truly undervalued (a small REIT I owned back in 2000 comes to mind).  But, for the most part, I've seen buy backs done that just didn't make sense.  And, I believe if we looked at short term and longer term performance, the markets will probably agree.  At least that is from my own experiences seeing these things. 

 

BUT, I would still love to see a rigorous study done on buy backs and share performance.  I think I've read an article on it once a long time ago, and I remember not being impressed by it.  I mean, if I was, I would be looking for good companies announcing large buy backs and using that as a strategy.  For some reason, I am not.  So, that tells me I haven't read anything so convincing to lead me to believe these are ultimately great things to the shareholder.

 

Personally, I would rather take a dividend versus a buy back.  But, better than either, a buy out at a set target price that is at a premium.

 

Never?

 

Malone, Singleton, Erbey is in the early innings, etc. I think there are plenty of examples.

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if you own a stock and rather get dividends' data-ipsquote-timestamp=' it means your holding a overvalued stock. You should look at that first. [/quote']

 

 

I like dividends because I'm not a taxable investor, and because I don't own my companies for their "capital allocation" skills so do not expect them to know when their stock price is low or high.

 

We want MOAR dividends.

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if you own a stock and rather get dividends' data-ipsquote-timestamp=' it means your holding a overvalued stock. You should look at that first. [/quote']

 

 

I like dividends because I'm not a taxable investor, and because I don't own my companies for their "capital allocation" skills so do not expect them to know when their stock price is low or high.

 

We want MOAR dividends.

 

If you don't expect them to know when their stock price is low or high, how could they ever know when to issue stock in a transaction, or as compensation, or more importantly, know what price to sell the company at?  Are you seriously okay with them doing whatever the advisory firm tells them?? 

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if you own a stock and rather get dividends' data-ipsquote-timestamp=' it means your holding a overvalued stock. You should look at that first. [/quote']

 

 

I like dividends because I'm not a taxable investor, and because I don't own my companies for their "capital allocation" skills so do not expect them to know when their stock price is low or high.

 

We want MOAR dividends.

 

If you don't expect them to know when their stock price is low or high, how could they ever know when to issue stock in a transaction, or as compensation, or more importantly, know what price to sell the company at?  Are you seriously okay with them doing whatever the advisory firm tells them??

 

If you aren't hiring them for their capital allocation skills, how can you trust them when they launch a new product (e.g. a crappy phone)?

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if you own a stock and rather get dividends, it means your holding a overvalued stock. You should look at that first.

 

If you do a study on the effectiveness on buybacks you are essentially doing a study on capital allocation skills of managers. And I can predict the outcome, the bad ones will underperform, and the great ones outerperform! And companies with very volatile stock prices that generate a lot of cash will benefit the most. But very few managers fully utilize the market swings to maximize returns to shareholders unfortunately. It is no coincidence that almost all the outsiders in thorndike's book did buybacks at the right time.

 

This is really simple, yet for some reason very misunderstood. People can't seem to grasp cheapness of a stock. Oddball's example perfectly illustrates that. The bad allocators are basicly sheep and dont have this inner voice of logic that dictates to do the right thing. They are swayed by the crowd. They say they base their decision on rational constructs, but are really just sheep.

 

I like dividends because I don't need to pay a commission to sell any shares.  Some of my holdings are very illiquid and a dividend puts real cash in my pocket rather than sitting on the ask for months.

 

Some of my holdings are in IRA's so dividends are tax-free for me in there as well, not that I let the tax-tail wag the dog..

the return difference between buying shares when they are undervalued vs paying dividends makes up for commission. Unless the bid ask spread is really wide. The cheaper the stock, the more value they destroy by dividend vs buyback for remaining shareholders, even if you pay zero taxes and commission when reinvesting the dividend. There is literally no scenario where dividend has any upside over buyback when the stock is cheap.

 

@palantir, ill assume your just trolling :) , otherwhise I will predict how this plays out. Ericopoly will come in and a 6 page discussion of dividend vs buyback will ensue.

 

edit: ok there are is one scenario where dividend is preferable, if insiders own a very large %. Or sometimes most shareholders will simply not sell at such low price. You need suckers to buy the stock from for this to work.

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If you aren't hiring them for their capital allocation skills, how can you trust them when they launch a new product (e.g. a crappy phone)?

 

I invest in them because they have a good business model, not because I believe that the CEO is a mythical "capital allocator", and as a result, I don't think their capital allocation skill matters in determining how great their phone is.

 

 

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If you don't expect them to know when their stock price is low or high, how could they ever know when to issue stock in a transaction, or as compensation, or more importantly, know what price to sell the company at?  Are you seriously okay with them doing whatever the advisory firm tells them??

 

That is one of the risks of investing in a public company, and you are at the mercy of management's decisions to the extent you cannot influence their actions. Some firms have great capital allocators who are good at this, but I don't think it is a requirement.

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Because if they do not buy it back, then they could some ridicilous acquisition. Or they invest in capex when that will likely not produce returns. Or they wait and buy back when the stock is expensive, missing out on enhancing your return when the stock moves to fair value.  Good capital allocation skills are very important and greatly enhance returns.

 

I mean if they have a good business model throwing off lot's of earnings, and those earnings get pumped in some no revenue shitty company that they end up having to write off, that can destroy a lot of value. It does not really matter in that case how good the business model is. Just look at HP. It was trading at 3.5x FCF at some point because of this. And look up the institutional imperative. the earnings of a company with a good capital allocator deserve a premium, and with a bad allocator deserve a discount. Even if you just abritrage the intrinsic value discount, it adds up. 

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if you own a stock and rather get dividends, it means your holding a overvalued stock. You should look at that first.

 

 

I like dividends because I don't need to pay a commission to sell any shares.  Some of my holdings are very illiquid and a dividend puts real cash in my pocket rather than sitting on the ask for months.

 

Some of my holdings are in IRA's so dividends are tax-free for me in there as well, not that I let the tax-tail wag the dog..

 

If you are maintaining your ownership %, then dividends and buybacks will be similar even for a taxable account. Most of the benefit of a buyback is in the extended IRS loan, so the advantages of a buyback accrues with more time and higher returns. If you are selling off the extra ownership within that first tax period, then your loan term is the same as a dividend.

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yeah but why would you buy a undervalued stock and start selling it off when it got even cheaper? if you wait with selling untill it starts reaching fair value your return will be bigger with buybacks vs dividends. Even if you reinvested those dividends at the same cheap multiple you bought the stock.

 

The idea of valueinvesting is buying cheap stocks and selling them when they get expensive. So why not sell another stock that is reachign fair value? Your basicly saying, well when a company buys back its own stock and becomes even cheaper and I want to sell... WHY would you sell at that point?

 

Let's take a company with

500m$ market cap

100m$ earnings

10m shares.

50$ per share.

 

you think it is worth 12x earning, or about 140% upside.

 

Let's say you hold the stock 4 years. But in those 4 years it trades at 5x earnings twice and never quite reaches fair value so you don't sell. The company uses the opportunnity to do two buy backs of 100m each. And in the other scenario they pay 2 dividends each that you reinvest when they are at 5x earnings.

 

After 4 years they reach 12x earnings (still making a 100m$)

 

we start out with 10k shares or 500k$. So first 20% of shares get bought back at 5x earnings. Or at 50$ per share. And then a second time when stock si cheap again, at 62.5$ per share (again at 5x earnings). so 3.6m shares bought back.

 

In the buy back scenario, when we sell we get 10k x 187.5$ per share (1200m$ / 6.4m shares) or 1.875 million $ 275% upside.

 

In dividend scenario, we start out with 10k shares, but end up owning 14k shares, 4k shares bought at same level shares were bought back (both when it was trading 5x earnings). Share price is 120$ per share (1200m$ / 10m shares) . Our stake is 1.68 million. Or 236%.

 

This shows how much value a company destroys by paying dividend instead of buying back when the stock is cheap. And this does not even include transaction costs or dividend taxes! I think the idea of valueinvesting is buying low and selling high, so complaining that you now have to pay commission on selling a very undervalued stock does not make sense.

 

And holding on to large cash piles when the stock is really cheap is basicly destroying shareholder value. Just difference between dividends and buybacks, your return was 16.5% higher in the buyback scenario.

 

This is also the reason why all the outsider companies outperformed so badly. Their CEO's realized the power of buybacks over dividends when the market was inneficient. Ofcourse you always have to consider the return  difference between buying back and reinvesting in the business.

 

If a company does this over 10 years time and buys back like 70% of their shares. The return difference is quite large, even if you reinvested those dividends at same low levels of the buybacks. On the top of my head, Your return is probably twice as good if they buy back the majority of shares at very cheap levels vs dividends reinvested instead at those same low levels.

 

Let me know if i made a mistake with my math.

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  • 2 weeks later...

 

"On his blog Millennial Invest Patrick O’Shaughnessy examined the performance of stocks ranked on net buyback yield over the period from January 1987 through to July 2014. O’Shaughnessy found that the decile of stocks that repurchase the most shares in a year outperformed the market by 3.87 percent in the following year"

 

That was interesting.  I haven't read the Dividend Yield approach by Faber, but I wonder what the difference in performance is.  Also, 1 year out performance could be a fluke.  I wonder what the longer term performance is like. 

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"On his blog Millennial Invest Patrick O’Shaughnessy examined the performance of stocks ranked on net buyback yield over the period from January 1987 through to July 2014. O’Shaughnessy found that the decile of stocks that repurchase the most shares in a year outperformed the market by 3.87 percent in the following year"

 

That was interesting.  I haven't read the Dividend Yield approach by Faber, but I wonder what the difference in performance is.  Also, 1 year out performance could be a fluke.  I wonder what the longer term performance is like.

 

If I recall, Faber's conclusion was that Shareholder Yield (Div + Net Buyback) was better than just net buybacks.

 

The problem with almost all of these research studies is that they only use 1 year holding periods.

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  • 8 months later...

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