When companies shrink the number of outstanding shares, earnings per share growth is boosted, which in turn enhances the stock price.Fred Lum/the Globe and Mail
A recent article in Report on Business pointed out that the earnings recovery in listed Canadian companies since the depth of the pandemic will permit many of them to boost dividends in the near future.
But some companies may also decide to return cash to shareholders by reviving or initiating a share buyback scheme. By shrinking the number of shares outstanding, earnings per share growth is boosted, which in turn should enhance the stock price.
If a buyback boom is also on the horizon, should the presence of a buyback program be one of the criteria used in selecting companies for additional research? The answer appears to be that it is certainly a positive feature at the individual company level, but building an entire portfolio strategy around it is less successful.
For analysis, we can turn to the S&P/TSX Composite Buyback Index, which has a history going back to 2014 and back-tested to 1998. The index represents the top 50 members of the S&P/TSX Composite ranked according to the cash spent on buybacks as a percentage of market capitalization. The calculation is updated quarterly, based on the preceding 12 months’ data and the index is equally weighted except in the case of multiple voting classes of shares.
The accompanying table shows annualized returns for the Buyback Index and benchmark S&P/TSX to Sept. 30, followed by the annualized risk as measured by the standard deviation:
A few things jump out from this table. Although a buyback-oriented strategy looks great for the past 12 months and positive for the past 10 years, the subpar three-year record and indifferent five years suggest that periods of superior return are lumpy. This is confirmed by the risk profile as measured by the standard deviation using monthly values: Over each period the risk of the Buyback Index is between 35 per cent and 46 per cent higher than the broad-based Composite. Taking this into consideration, the risk-adjusted annualized returns for the two indexes are virtually identical, according to the data published by the index compiler.
After looking at the composition of the Buyback Index in more detail, perhaps we should not be surprised by the fact that it is more volatile; it has only 50 constituents compared with 234 in the Composite, and the industry profile can be quite different. At the end of September, for example, Financials made up 32 per cent of the Composite and only 25 per cent of the Buyback. Having said that, because it is made up only of Composite members, the Buyback Index is quite liquid, with a median market cap of $5-billion – a little larger than the benchmark’s, which clocks in a $4.3-billion.
As is the case with small cap relative performance, it is difficult to separate the influence of the factor under scrutiny (smallness, buybacks) from the influence of the differential in industry weights in any two indexes. Which is why I suggest that a buyback program deserves a check on the positive side during a company analysis, but it does not merit a full-scale portfolio strategy.
Canadian investors appear to have come to the same conclusion some time ago: The CI First Asset Canadian Buyback Index ETF, based on a slightly different methodology and launched in 2016, apparently failed to gain traction and was merged into a dividend growth exchange-traded fund in April of this year.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.
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Robert Tattersall