Companies in the resource sector are less inclined to distribute excess cash through buybacks. But the oil price shock could bring about a cautious streak among executives, who may come to favour buybacks over investing in capital.birdigol/Getty Images
There are no greater supporters of stocks than the companies that issue them.
Flush with cash and disinclined to spend it on riskier ventures, the U.S. corporate sector is directing ever more substantial sums to the repurchase of their own stock. That source of demand has come to represent a key pillar of the bull market, one that bears no indications of weakening.
"The trend is still in place," said Brian Belski, chief investment strategist at BMO Nesbitt Burns . "Until we see several interest rate hikes, and that will take several years, I don't see any dramatic reversal in buybacks."
That's welcome news for investors. Over the course of the bull market, U.S. companies aggressively buying back stock have generated superior returns, on average. The trend has been less apparent in Canada, but the right conditions have recently emerged for a spike in domestic buyback activity, Mr. Belski said.
Companies in the resource sector, which are in abundance in Canada, are less inclined to distribute excess cash through buybacks. But the oil price shock could bring about a cautious streak among executives, who may come to favour buybacks over investing in capital. The recent Bank of Canada rate cut, which makes borrowing money to fund buybacks even cheaper, could also fuel the trend, Mr. Belski said.
The U.S. market has long featured conditions favourable for buybacks, which include low interest rates, high profits and an aversion to risk. "Buybacks reflect a continued conservatism among CEOs and CFOs as to what to do with their excess cash flow," said Richard Bernstein of Richard Bernstein Advisors.
Soaring profitability throughout the recovery has generated vast corporate cash reserves. S&P 500 companies hold about $1.75-trillion (U.S.) in cash and marketable securities, according to Bloomberg.
A perennially tenuous economic outlook, combined with the lingering trauma from the financial crisis and ensuing recession, instilled a reluctance to invest in anything long term.
Buybacks, however, are a quick way to deploy cash, placate investors and boost earnings per share. They reduce the outstanding share count, giving remaining shareholders a greater stake in the company's earnings. Dismissed by its harshest critics as a scam, the buyback can be used to mask deteriorating fundamentals by generating earnings per share growth in the absence of growing profits.
Some detractors have for several months predicted a declining reliance on share buybacks. Investors would begin to favour companies investing for growth, they said. Corporations would begin to divert buyback money to capital expenditures. Rising rates would reduce the inclination to borrow money cheaply to finance buybacks. And the spiking U.S. dollar would reduce profits. All of which have failed to chip away at the prevalence of buybacks or investors' preference for them.
S&P 500 companies have spent more than $2-trillion buying back their own stock since 2009. In February, those companies announced a record $104.3-billion in planned repurchases, according to TrimTabs Investment Research, amounting to more than $5-billion per day.
Even as S&P 500 profits were being revised downward in February amid the U.S. dollar rally, the index advanced by 5.5 per cent – further evidence of the market influence of buybacks. In fact, over virtually any extended period of time since the beginning of the bull market, the S&P 500 Buyback Index, which tracks the performance of the 100 stocks with the highest buyback ratio over the past year, has beaten the market.
Since the market bottomed out in March, 2009, the broader index has more than tripled, while the buyback index has increased by a factor of 4.6 times.
The lesson for investors is clear, said Ryan Lewenza, a strategist at Raymond James. "Continue to buy stocks that are returning capital," he said, emphasizing the need to identify repurchasers that are also growing. "The numbers show that those that are buying back stocks are outperforming."
Canadian fund managers' buyback picks
While buybacks haven't been quite as prevalent in Canada as in the United States, there are many high-quality Canadian companies actively repurchasing shares. Here are some Canadian fund managers' picks of stocks with strong buyback history and potential.
David Baskin, president, Baskin Financial
Bank of Nova Scotia (BNS-T)
Scotiabank has a high enough capital ratio to afford the flexibility to buy back stock, which the bank has done at reasonable valuations, Mr. Baskin said.
Stan Wong, director of wealth management, ScotiaMcLeod
Telus Corp. (T-T)
In addition to its dividend, Telus has a program to repurchase $2.5-billion in shares by the end of 2016.
Ryan Lewenza, strategist, Raymond James
WestJet Airlines Ltd. (WJA-T)
WestJet has reduced its share count by 22 per cent since 2010 and plans to buy back another two million shares over the next 12 months.