You know the rule: Buy low, sell high.
Public companies, it seems, haven’t learned this basic investing lesson. They’re buying back more of their own shares than ever before: In 2018, on the heels of tax reform, the amount of buybacks surpassed $1 trillion in a year for the first time ever.
While the amount may not grow too much more in 2019, results from the year’s first quarter suggest they’ll come close in line with 2018’s levels. (See “The Winners and Losers in a $1 Trillion Buyback Year.”)
Yet it’s clear that companies aren’t timing those buybacks well.
Each year, Fortuna Advisors, a financial strategy firm, calculates the effectiveness of S&P 500 companies’ buybacks over the previous five years, using a metric it calls“buyback ROI.” That statistic measures how well each company’s stock performs after that company repurchases shares, combined with other metrics including the savings the company earns by no longer paying dividends on the shares it bought back.
Fortuna released its latest study on such data earlier this year. For the third straight year, by Fortuna’s accounting, Nvidia had the best buyback ROI, at 70.4%. (It helped that the stock saw a 750% increase in price over the same time period) Most companies, however, aren’t particularly strong at timing their buybacks. The median buyback ROI for all S&P 500 companies came in at 8.1%, down from the 13.8% mark last year.
Here’s why that matters: A low ROI implies that companies are buying back their shares at closer to peak prices—which means, basically, that they’re overpaying. In theory, that leaves those companies with less money on hand than they’d otherwise have for other necessary investments (like R&D, acquisitions, buying robots or hiring new staff).
Ideally, you’d want your company buying back shares when they’re undervalued. It’s hard, however, to implement a strategy of only buying shares when the stock price looks cheap, says Fortuna founder and CEO Gregory Milano, because management “always thinks it’s cheap.” What’s more, companies tend to have more cash in their coffers for buybacks when business cycles – and stocks – are at their peaks.
Source: Stocks: Too Many Companies Are Paying Too Much for Buybacks | Fortune