BuyBack Yield Isn't The New Magic Bullet
Richard Shaw | Jun 16, 2013 05:02AM ET
BuyBack Yield is an interesting concept, and a useful tool as part of stock analysis. However, it SHOULD NOT be used as a security selection or rejection criterion without interpretation with other data. What seems good could be bad, and what seems bad could be good.
There are some advisors talking up BuyBack Yield as if it is some kind of new magic bullet for yield seekers. Well we think it ain’t so.
It is a good idea for yield seekers to look for as much supplemental evidence of strength and shareholder reward as possible, and BuyBack Yield has a role in some cases as a preliminary indicator. However, BuyBack Yield can just as easily mislead you as point you in the right direction unless it is accompanied by careful consideration of other fundamentals, as well as industry and company specifics.
BuyBack Yield simply measures the percentage change in outstanding shares over a period of time.
The argument for BuyBack Yield is that if a company is using earnings to purchase its own shares, it is concentrating earnings — in effect yielding earnings to shareholders more efficiently than shareholders could do by receiving dividends, paying taxes on them and then purchasing more of the company’s stock.
For dividend paying companies, a combination of dividends received and earnings accretion due to share buybacks creates an extra dose of value creation. That is an appealing argument for what some call “Total Yield” (BuyBack Yield + Dividend Yield).
Certainly the idea warrants measuring BuyBack Yield and Total Yield, but the data must be taken into context to avoid undue positive or negative views of a stock, and to avoid ranking stocks by Total Yield in a way that is misleading.
How Might BuyBack Yield and Total Yield Be Misleading?
- If a company issues shares to acquire another company, even if the acquisition is accretive to earnings, the BuyBack Yield is negative and the Total Yield is reduced and may be negative. That would be misleading, unless you are simply opposed to acquisitions.
- If a company issues shares to investors to raise more capital when the stock price is high, and the new capital is to be used for CapEx for business expansion, the BuyBack Yield is negative, but the implication may be positive.
- If a company reduces its outstanding shares by a repurchase program when the stock valuation multiple is high, the BuyBack Yield is positive, but if the valuation multiple is unreasonably high and likely in your view to revert to a lower multiple, then that positive BuyBack calculation would be a false indication of a positive effect
- If a company reduces its outstanding shares with a repurchase program, but at the same time awards executives boat loads of stock options, the intermediate-term to long-term value of the BuyBack Yield calculation could be very much in question
- Companies that step in with both feet to buy shares in a down market are often making a good choice, but the short-term BuyBack Yield at that time cannot reasonably be projected into the future, and long-term average BuyBack Yield may be distorted by a recent spike in share purchases due to a market downturn.
- BuyBack Yield based on the past 12 months (as is the case with the NASDAQ BuyBack Index) is far less useful than dividend yield as a long-term yield indicator, because share repurchase programs are often highly variable from year-to-year, whereas dividends have a far greater tendency to be carefully managed for consistency and growth.
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You may be able to think of other examples. The point is that dividends are what they are — cash in your hand, but BuyBack Yield may or may not be as good or as negative as a simple calculation and/or ranking would suggest.
We think BuyBack Yield is an interesting and useful tool, but one that must be taken in context of more information about why and how the BuyBack Yield came about. We think just looking at the 12-month BuyBack Yield is particularly dangerous for yield seekers, and instead or in addition investors should also look at multi-year average BuyBack Yields.
EXAMPLE RAW DATA:
We identified the 135 stocks available in the USA as of 06/07/2013 with 3% or more in trailing yield, and 3% or more in dividend growth over the last 4 quarters, and also on average over 1, 2, 5 and 5 fiscal years. Within than universe, we looked at 12-month and 5-year BuyBack Yield.
Seagate Technology (STX) has the highest 12-month BuyBack Yield at 19.7%, bringing the Total Yield to 23.2%. But its 5-year BuyBack Yield is only 5.2% — still a nice number, but no where near 19.7%.
We would suggest a Total Yield of 8.7% is more reasonable than 23.2% for STX. We have not research the why or how their repurchases took place, but with this data simply illustrate the importance of taking a longer view of share repurchase behavior.
Here is a chart from YCharts.com showing their trailing BuyBack Yield and dividend yield for the last 10-years — you can see the comparative irregularity of the BuyBack Yield versus the dividend yield:
Along the same lines, Vodafone (VOD), which has a 5.3% dividend yield, has a 5.8% 12-month BuyBack Yield, but only a 1.5% 5-year BuyBack Yield.
On the other side of the question, Raytheon (RTN) has a 3% 12-month BuyBack Yield and a 5.3% 5-year BuyBack Yield.
Again, we have not researched the acquisition, CapEx, R&D, or options granting behavior of these companies; but we think the raw data shows the high variability of BuyBack Yield data over different time periods. That argues against the 12-month approach for long-term views, in our opinion.
Some companies that appear to show good consistency, such as Chevron (CVX), which has a 1.8% 12-month BuyBack Yield, and a 1.6% 5-year BuyBack Yield have nonetheless significant variability on a period-to-period basis, while their dividend yield shows comparatively high consistency.
What about companies with large negative BuyBack Yields? We don’t think it tells you that much with capital intensive companies.
Take Northeast Utilities (NU) for example. They have a negative 77% 12-month BuyBack Yield, and a negative 14.1% 5-year BuyBack Yield, and a 3.5% dividend yield. Assigning a negative 73.5% or negative 10.6% Total Yield to them seems rather useless. By the nature of the industry, their BuyBack Yields would tend to be negative.
Of the 18 Utilities in the 135 stocks in our sample, only 3 have positive 12-month and 5-year BuyBack Yields. Maybe they are doing well, or maybe they have declining demand, or are deferring CapEx. We would have to look into that, and in fact intend to do so; but overall utilities and BuyBack Yield may not go together well.
Those three positive BuyBack Yield utilities are: Wisconsin Energy Corporation (WEC), Alliant Energy Corporation (LNT) and Dominion Resources (D). Their 10-year BuyBack Yields are shown in this chart:
There is a slight difference in the data in our source database and the one used by YCharts, but the numbers are close enough for illustrative purposes. Different databases almost always have some differences, and virtually all databases contain some errors, so don’t get too lathered up about small discrepancies, and before making final decisions check original sources.
Another interesting example is Enterprise Products Partners LP (EPD), the largest pipeline MLP.
Their dividend yield is about 4.4%. Their 12-month BuyBack Yield is positive 0.8%, but their 5-year BuyBack Yield is negative 38.4%. Which would you use for Total Yield?
We wouldn’t use either one, because MLPs payout most of their cash flow and must either issue more shares or borrow more money to expand. Eventually there are borrowing limits, and parent entities might typically take shares for asset “drop downs” into MLPs. In any event, we don’t think BuyBack Yield is useful for companies like this.
The same may be true for REITs. Consider Digital Realty Trust (DLR), with a negative 18.1% 12-month and negative 13.9% 5-year BuyBack Yield. Equity REITs payout most of their cash flow and need to borrow or issue shares to expand.
There are companies, though, where BuyBack Yield does make sense to us, and may help identify better opportunities. Kimberly Clark (KMB), GlaxoSmithKline (GSK) and McDonalds (MCD), may be examples. They have been reasonably consistent in their repurchases, but also stepped in big during the 2008 crash when they could buy earnings cheaply.
BUYBACK ACHIEVERS ETF:
There is an ETF that focuses on the NASDAQ BuyBack Achievers index (based on trailing 12-months of outstanding shares data) PowerShares BuyBack Achievers Portfolio (PKW). It has done very well, beating the S&P 500 (SPY) and the S&P 1500 High Yield Dividend Aristocrats (SDY).
That does not however, mean that BuyBack Yield is an effective universal tool to evaluate effective Total Yield to shareholders. What it means is that recent strong share repurchases correspond to near-term subsequent price increases. We give that approach full kudos, but we caution not to extrapolate that phenomenon to the yield seeking goal. They are two different things.
To be eligible for inclusion in the index, a stock must have repurchased at least 5% of its outstanding shares in the past 12 months. The index is rebalanced quarterly.
Here is price performance. PKW wins.
Here is the rate of change of dividend payment amounts for the ETFs. The share repurchase criterion does not correspond to a superior rising dividend.
CONCLUSION:
We recommend looking at BuyBack Yield as part of your stock evaluation process, but also looking past BuyBack Yield as to why and how it cam about before relying upon it as a yield seeking investor.
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