Companies started this year with plenty of cash, thanks to a big tax cut, and they’ve put that money to work in the market.
Specifically, they’ve been buying their own stock.
Even Warren Buffett’s Berkshire Hathaway joined the crowd, announcing recently it had acquired nearly US$1-billion of its own shares in the last few months.
Through November, U.S. companies bought a record US$957-billion of their own stock and were on pace to top the US$1-trillion mark for the year, according to San Francisco-based TrimTabs Investment Research, though the activity does tend to slow in the last weeks of December.
Stock buybacks could be a bullish sign. Companies snatching up bundles of their own shares would seem to be signalling that they are undervalued and that their businesses are operating well enough to project future growth.
Part of the tax overhaul in late 2017 was an incentive for U.S. companies to bring money stashed overseas home, and that is a big reason for the boom in buybacks this year. It is a simple and relatively quick way of putting that newly repatriated cash to work.
Apple, for example, said earlier this year it would buy back an Earth-shattering US$100-billion of its shares, the biggest in history. Cisco announced plans to buy US$25-billion, while Wells Fargo unveiled a US$22.6-billion program.
For Berkshire Hathaway, the move to buy US$925-million of its shares in the open market was greeted with cheers from investors, who pushed its B shares up 5 per cent after the news came out.
Apart from stock purchases, companies can use extra cash sitting on their balance sheets to pay down debt, as AT&T has promised to do over the next year or so while still paying its dividend. Or they can use it to invest in their businesses, as Amazon is doing by raising wages and opening two new headquarters in Virginia and New York. They can also pay shareholders directly in the form of a dividend.
Acquisitions are another way to use cash, and there were nearly three dozen megadeals of over US$10-billion announced in the United States through the first half of the year, according to Dealogic, a U.K.-based financial analysis firm.
But buybacks have the added benefit of reducing the overall share count, which can boost earnings per share (EPS). Some have argued that this is a temptation for companies to try to juice their numbers or boost EPS to benefit executives at bonus time. And they don’t really boost the economy, which was supposed to be the idea behind the tax cuts.
There is a darker side to consider: Companies are using their extra cash to buy back their stock because they don’t see any more useful ideas for the money. When companies lack more profitable ideas, they tend to return the money to their owners, the shareholders.
Berkshire changed its rules on buybacks earlier this year, giving Mr. Buffett and his long-time lieutenant Charles Munger more leeway to decide whether it was time to dive in and buy. Sure, Berkshire has struggled to find another use for its cash. It bowed out of some acquisition ideas last year, in one case after a bidding war broke out, and it hasn’t found many companies to buy that aren’t richly valued.
Mr. Buffett has long pushed the idea of buying an asset when it is trading below its “intrinsic value,” which is an estimate of the future cash output of a business discounted to present day. And Berkshire’s intrinsic value has grown more than its book value in recent years.
Investors took some comfort that in buying back its shares, Berkshire was making a signal it was prepared to stay disciplined about acquisitions and not over-spend on deals just because it had money burning a hole in its pocket.
Maybe that’s the same signal other companies are giving.
At Validea, we have put together a set of investing models that track the strategies deployed by some of the greatest investors, including Mr. Buffett. Here are three companies that score highly among companies that have announced buybacks in the last year.
Biogen Inc. (BIIB-Q) – This biopharmaceutical company scores highly on the models tracking the styles of Warren Buffett and Peter Lynch, the former portfolio manager at Fidelity. It has an average return on equity over 10 years of 22.7 per cent. Earlier this year it announced a US$3.5-billion buyback. At the current market valuation, that’s about 4.5 per cent of the company.
Alliance Data Systems Corp. (ADS-N) – This stock also scores highly on the models tracking Mr. Buffett and Mr. Lynch. The marketing data and loyalty program provider has long-term earnings consistency and high returns on capital and equity. It also has a US$500-million buyback plan, which equates to approximately 4.6 per cent of its market cap at current prices.
Diamond Hill Investment Group (DHIL-Q) – This small-cap stock scores well on the Buffett and Lynch models. The investment adviser and fund administrator, which announced a US$50-million buyback in September, has a 10-year annual earnings growth rate of 13.5 per cent and strong free cash flow.
John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service.