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17 November 2011: SH: Share buybacks: taking advantage of current market volatility

-Jamie_Lowry

 When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases” – W.E. Buffett (1984)…


Jamie Lowry, European Equity Fund Manager


For professional investors and advisers only. This document is not suitable for retail clients.


A long-term investor’s stated goal is to take advantage of irrational behaviour in stockmarkets to purchase shares at a discount and earn superior rates of return. Yet, investors like us, are not the only market participants who can take advantage of market volatility; companies are  able to buy back their own shares on our behalf. We are actively engaging with company management in the current environment to recommend share repurchase programmes, but only where it makes sense to do so.
Share buybacks have become an increasingly popular method of ‘returning capital to shareholders’. In the US markets in 1977, only 5% of capital was distributed to shareholders via a share buyback with the remaining 95% given via dividend. It took only 20 years before share buybacks accounted for over 50% of total cash distributions for the first time1.Unfortunately, amid this rise in popularity, corporate management forgot a very simpleprincipal – a share buyback is not a method of ‘returning capital to shareholders’, but an investment.
17-11-2011
A share buyback is an investment in one’s own shares; hence, one should treat it like any other investment – buy low, sell high. We can see from the above graph that US corporations have been particularly poor at following this advice. Total cash distributed via share buybacks reached a peak of $589 billion in 2007 when, not coincidently, the S&P 500 also reached its recent peak. It is little wonder that market opinion has been decidedly mixed in recent years regarding the benefits of share repurchase programmes.
17-11-2011_1
However, the table above sheds some light on the ability of share repurchases to add shareholder value. For example, if a company repurchased its own shares when it was valued in the most expensive 20% of the market (a ‘glamour’ stock in this table), its three year total return would have been 53% against 55% for its reference portfolio of ‘glamour’ stocks. That is, expensive companies who repurchased their own shares performed worse than other expensive companies, in spite of spending shareholder cash on repurchases.
Happily, however, the story ends well for those companies which consider the valuation of their own shares before pursuing a buyback programme. While cheap companies in general (i.e. the cheapest 20% by price/book ratios in this instance) performed well over the three-year period, recording a total return of 69%; those companies that repurchased their own ‘cheap’ shares, delivered a total return to shareholders of 104%.
Conclusion
While the current volatility in equity markets allows us to deploy capital in the opportunities created; long-term investors are also able to engage management and proactively discuss share buybacks as a method of enhancing returns. If we pick our opportunities well, we should not only expect to benefit from the underlying growth of these companies, along with a rerating of their temporarily depressed share price, but also from sharing the spoils with fewer investors as management reduce the number of shares outstanding.

1 Source: Legg Mason, 2006, ‘Clear Thinking about Share Repurchase’ available at http://www.capatcolumbia.com


Important Information:

The views and opinions contained herein are those of Azad Zangana, European economist, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. For professional investors and advisers only. This document is not suitable for retail clients. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Schroders has expressed its own views and opinions in this document and these may change. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Services Authority. For your security, communications may be taped or monitored.


Source: ETFWorld – Schroders

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