Banking On Buybacks for Protection

In the shareholder rewards conversation, clients often focus on dividends over buybacks. After all, the novices and uninitiated perceive dividends as “free money.”

Advisors know better. There's no such thing as a free lunch in financial markets and share repurchase programs come with benefits some clients may not be aware of. Those include no taxes passed on to investors, reduction of shares outstanding/potential to boost earnings per share and flexibility – simply because ABC Corp. says it's going to buyback $5 billion worth of its shares, that doesn't mean it has to. Conversely, a company that commits to a dividend and later shirks that obligation is usually punished by investors.

And like dividends, buybacks are growing in a big way.

“We are watching the $7tn in cash that US corporates have accumulated heading into 2022. If companies deploy their cash (without any increase in leverage) in historically typical ways, dividends, buybacks, capex and acquisitions could rise $300bn this year (+16%) to a record $2.1tn,” according to Bank of America Global Research.

Notably, companies that dedicated to buying back their own shares often outperform competitors that aren't following suit.

“The S&P 500 Buyback index has outperformed the S&P 500 by 3.7% since 1994 on a monthly total return basis. Our equity team’s Buyback factor has also tended to perform well in periods of Fed tightening with a median total return of 6.7% since 1986,” adds Bank of America.

Fine Idea for Accessing Buybacks

For advisors searching for broad baskets of buyback-intensive companies, there are several exchange traded funds dedicated to that cause.

One that isn't a specific buyback ETF, but one that is rich in repurchase-heavy companies is the WisdomTree U.S. Value Fund (WTV), which screens for shareholder yield. Buybacks, along with debt reduction and dividend growth, are a hallmark of shareholder yield. Important fact: WTV is proving quite durable amid broader market calamity this year.

“That isn’t surprising. The six major bear markets of the last half-century devastated companies that were heavy equity issuers, the kinds of stocks WTV's buyback screen tends to avoid. In crashes, the diluters plunged,” says Jeff Weniger, WisdomTree head of equity strategy. “While “nobody makes money in a bear market,” owners of the “buybackers” lived to see another day.”

As is often said, history doesn't always repeat in the markets, but it frequently rhymes. Whether it's rhyming or repeating, as Weniger points out, profligate issuers of their own shares – the antithesis of big share repurchasers – are often severely repudiated in bear markets.

For example, look at the 1968–1970 bear market. The heaviest shareholder diluters were halved. Then they caught a three-year rally, only to be halved again in the 1973–1974 bear market,” adds the WisdomTree strategist. “Or the dot-com wreck. The big diluters declined by two-thirds over three years. In all three of those bear markets—and in the others—the stock repurchasers remained standing.”

Quantifying the Opportunity

With a buyback bonanza expected this year and WTV already holding up better than the broader market, advisors have good reason to discuss the product with clients, but sometimes it boils down to simple yet convincing data points.

WTV “has a net buyback yield of 5.6%, which is akin to a $10 billion market cap company buying back $560 million worth of stock in a year. That is four times as high as the S&P 500’s net buyback yield of 1.4%,” concludes Weniger. “WTV has annually beaten both the S&P 500 Value and the Russell 1000 Value Indexes by more than a percentage point since its inception a generation ago through March 7, 2022. It has zero exposure to share diluters.”