It’s tempting to look at share buybacks as the ultimate insider nod: a company betting on its own stock. If that’s the case, though, companies are lousy at market timing.
That’s something to keep in mind after Manulife Financial Corp. MFC-T announced this week a $1.2-billion share buyback, at a time when its share price is trading at its highest level since 2008.
When a company initiates a buyback, it reduces the number of outstanding shares – a substantial 2.8 per cent, in the case of Manulife – from circulation. That means that corporate profits are divided among fewer shares, boosting earnings on a per-share basis.
That’s good for shareholders, who can be rewarded with gains. Buybacks are tax-efficient, too, since investors are not receiving cash.
Meanwhile, management looks smart for driving up profits and receives praise for being shareholder-friendly.
It’s little wonder, then, that companies have been embracing buybacks. According to data from Alice Bonaime, associate professor of finance at the University of Arizona, 71 per cent of U.S. companies in 2022 initiated buybacks, up from 49 per cent in 2012.
The share of companies delivering only dividends shrank to 7 per cent in 2022, down from 18 per cent a decade ago.
But as a market-timing signal, buyback activity leaves a lot to be desired: Companies, in aggregate, often buy their own shares when prices are high and ignore buying opportunities when their stocks are cheap.
“Companies may believe they are buying low, but the evidence in support of managers successfully timing the market is at best mixed,” Ms. Bonaime said in an e-mail.
This is likely because stock prices and repurchases tend to rise when corporate earnings are high, she said. Companies often cut back on repurchases during recessions, when profits are down and hoarding cash may be necessary.
She added that stock options can also play a role here. Employees tend to exercise their options when share prices are high, pushing companies to initiate buybacks to combat the dilutive effect of issuing new shares.
Recent activity supports this pattern. Buybacks among companies in the Standard & Poor’s 500 index plummeted 29 per cent in 2020, when lockdowns and disrupted economic activity associated with the COVID-19 pandemic walloped stocks. In other words, companies spent less on their own shares when they were cheap.
Buybacks have come rolling back since then, with a noticeable dip in the second half of this year when high interest rates raised the prospect of a recession.
If the pattern repeats, expect more buybacks after the S&P 500 rallied this week following signals from the Federal Reserve that it may be done with rate hikes.
Should investors be worried?
In the case of Manulife, the buyback announced this week follows a deal with Global Atlantic to reinsure Manulife’s long-term care reserves, reducing the risks associated with the insurer’s portfolio of assets and freeing-up $1.2-billion in capital.
Analysts liked the deal, and so did investors. Manulife’s share price increased 3.2 per cent on Monday, the day of the announcement, marking the stock’s biggest one-day gain since February. The stock closed at $28.66 on Thursday, and is now trading at its highest level in 13 years.
Rather than reinvest the freed-up capital or distribute it to shareholders in the form of another dividend hike, Manulife has already received regulatory approval to buy back shares, starting in February. This follows a $1.9-billion buyback in 2022 and $1.5-billion so far in 2023.
In many ways, another buyback makes sense. The dividend yield is already high, at 5.1 per cent, suggesting that investors who like regular cash distributions are getting what they want - and increases tend to arrive annually anyway.
“We continue to see investment in organic growth and sustained increase in the dividend as our capital deployment priorities,” a Manulife spokesperson said in an e-mail. Manulife last raised its dividend with the announcement of its fourth-quarter results earlier this year, and is expected to raise the payout again in early 2024.
The insurer made no mention of using the additional buyback to take advantage of a cheap stock that is poised to rally, so it can’t be accused of making a bullish call here.
Sure, the stock could perform well if the economy picks up next year as central banks declare victory over inflation. But investors might want to accept the buyback for what it is: A nice perk, but hardly a reason to jump into a stock.