As we move into the end of August, it becomes harder to ignore the imminent arrival of a new school year.
While students are busy preparing, investors might bone up on the gains that stocks with buybacks can provide.
Buybacks, or share repurchases, offer companies an alternate way to return money to shareholders other than paying dividends. Companies that buy their own shares (or pay dividends) are usually profitable and, hopefully, have an excess of cash to deploy, which can make them good investments.
The basic buyback portfolio tracks such companies by investing in Canadian stocks that have reduced their share counts over the past year. It sports an average annual growth rate of 14.7 per cent over the roughly 26.6 years from the end of 1999 through to the end of July, 2026. In comparison, the overall Canadian stock market, as represented by the S&P/TSX Composite Index, climbed at an average annual rate of 8.3 per cent over the same period.
(The basic buyback portfolios are model portfolios. The returns herein are based on backtests using monthly data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs. The portfolios are equally weighted and rebalanced monthly.)
More specifically, the basic buyback portfolio starts with the largest 300 common stocks on the Toronto Stock Exchange by market capitalization. It then buys an equal dollar amount of those companies that reduced their shares outstanding over the prior four fiscal quarters.
Buyback yield is determined by calculating the percentage reduction in a company’s shares outstanding over the prior four fiscal quarters. So, if a company recently cut its share count by 5 per cent, its buyback yield would be 5 per cent.
Dividend investors tend to gravitate to stocks with higher dividend yields – and moving to higher buyback yields provided some benefit over the past 26.6 years. Mind you, the largest boost came from excluding stocks with very low buyback yields.
Four variations of the basic buyback portfolio help to show the impact of sticking to stocks with higher buyback yields. They all start with the largest 300 Canadian stocks but then pick those with buyback yields of more than 1 per cent, 2 per cent, 3 per cent or 5 per cent. The portfolios sported average annual gains of 15.3, 16.3, 15.5, and 15.1 per cent respectively over the 26.6 year period.
But it’s important to be aware that the portfolios held fewer stocks as their buyback yield requirements climbed. The accompanying graph shows how the number of stocks in the portfolios varied over time. It highlights the portfolios with buyback yields in excess of 0 per cent, 1 per cent, 3 per cent and 5 per cent, which held an average of 65.9, 41.1, 21.0 and 10.4 stocks respectively.
Overall, corporate share repurchase programs became more popular over the 26.6 years with the number of companies buying back their own shares roughly doubling from near 60 in the late 1990s to about 120 today.
On a concerning note, the portfolio holding stocks with buyback yields of more than 5 per cent nearly ran out of stocks to buy in 2003 when only one company qualified for a couple of months. Similarly, there were five separate months during the 26.6 years when only two stocks passed the test.
On the other hand, the portfolio following stocks with buyback yields of more than 3 per cent was a little more robust because it always held at least six stocks, and it held fewer than 10 stocks in only 11 months over the 26.6 years.
Investors should be mindful that the buyback portfolios are not risk free. For instance, the top performing portfolio of stocks with buyback yields of more than 2 per cent fell by 41 per cent from its former highs in the crash of 2008-09, which was just a tiny bit better than the 43 per cent decline of the market index. It lagged the index significantly in the crash of 2020 when the market index fell 22 per cent and the portfolio, again, plunged 41 per cent. On the other hand, the portfolio held up better in the early 2000s when the market index slumped as the internet bubble deflated.
Details on the 20 stocks in the Basic Buyback portfolio with the highest buyback yields, and the stocks in the other portfolios regularly followed at The Globe and Mail, can be found via this link.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.