By Alexander Green | Chief Investment Strategist | The Oxford Club
For weeks I’ve argued that the best investors use down markets as buying opportunities.
(And the worst use them as opportunities to sell.)
Among the best investors are American public companies themselves.
U.S. stock buybacks are hitting record levels.
S&P 500 companies plowed $880 billion into buying back their own shares last year, up from $520 billion in 2020.
Yet new repurchase announcements topped $300 billion in the first quarter alone.
Goldman Sachs predicts that this year’s buybacks will easily exceed $1 trillion.
This is good news indeed.
Academic studies have consistently found that the average stock not only rises immediately after the announcement of a repurchase program but continues to beat the market for years.
The correlation between buybacks and stock outperformance is not hard to understand. There are two primary reasons.
The first? When management feels so strongly that the company’s shares are mispriced that they are willing to invest hundreds of millions of dollars of the company’s money to repurchase the stock in the open market, they are essentially betting their jobs on the company’s shares being undervalued.
I say that because those responsible for the decision are unlikely to keep their seats in the boardroom if the stock finishes the buyback period significantly lower than it was at the beginning.
The other reason is simple math.
When you divide earnings by a smaller number of shares outstanding, you get higher earnings per share. And that’s what ultimately drives share prices northward.
However, a little due diligence is in order.
Buybacks often do nothing more than offset the dilution that occurs when senior executives exercise their options, buying shares at a huge discount to the market and then selling them immediately to lock in gains.
In that case, the number of shares outstanding remains largely unchanged.
You need to make sure the number of shares outstanding actually declines.
Also, companies that announce their “intention” to buy back shares do not always follow through.
The financing or cash flow may not be available. Industry conditions may take a turn for the worse. Or management may simply change its mind.
But when the buyback proceeds apace and the number of shares outstanding declines, it’s a good thing.
And over time, buybacks can be highly significant.
For instance, in 1993 IBM had 2.3 billion shares outstanding.
However, by regularly buying back shares in the open market, the company has shrunk the number of shares outstanding by about 1% per quarter.
Today IBM has only 899 billion shares outstanding, 61% less than it had three decades ago.
Someone who clearly approves of this strategy is Warren Buffett.
His holding company Berkshire Hathaway (NYSE: BRK-A) seeks out companies that are actively buying back shares.
And Berkshire also regularly buys back its own shares.
Indeed, it bought back $2.2 billion worth in the first quarter alone – and has bought back tens of billions of dollars’ worth over the past few years.
Note, too, that Berkshire – like IBM – is up this year, not down.
Buffett knows that companies that reduce their share count are returning capital to investors.
That’s one of the best stock market signals you can get.
Of course, the important question is not the aggregate amount of share buybacks but rather, “Who is buying and how much?”
Investors have to be selective. Ultra-selective.
That’s why on Thursday, June 9, at 8 p.m. ET, I’m sitting down with longtime subscriber and bestselling author Bill O’Reilly to discuss exactly this phenomenon – and how everyday investors can take advantage of it in their portfolios.
To sign up for this free event, simply go here.