Repurchase Programs and Stock Price

From Our November 2014 E-mail Archives: One of our traders wondered if there was a trading strategy that could be used on companies that had significant share repurchase programs. Our Head Trader, Robb Reinhold, answered the question.*


-----Original Message-----

From: David B.
Subject: Buyback Question

Hi Robb and Joe,

I was just wondering if either of you have ever done any research on companies that have announced or have large stock repurchase authorizations in place and the impact on their stock price?

Obviously, companies have blackout periods (e.g., before earnings) when they cannot buy back stock. However, I would imagine that these authorizations could provide some support for the stock price. Therefore, after earnings, these companies are likely to trade sideways or have an upward bias.

If the stock trades in this manner, then it would appear to me that they could be good candidates for slightly out of the money credit spreads or diagonals. I hear you guys talk a lot about finding stocks that are not going to go down and, to me, these could fit.

Am I wrong in my rationale? Do you have any thoughts or experiences?

Thanks,
David


-----Reply Message-----

Hi David,

Thanks for the question – this is an interesting one. The big problem about buybacks is that even though the company can announce a 1 billion dollar buyback, they don’t actually have to do anything. So, there is no way to know in real-time how much the company is trying to buy back at the moment. Most companies do report their buyback amount per quarter with earnings, but that is not required.

Overall, companies that are actively buying back stock after buyback announcements tend to move higher. I don’t have any hard data (it might be out there on Google), but I did pull up a quick story from The Economist – click here to read the story.

I skimmed through the article and didn’t see any hard data over a long period of time that would support our hypothesis that companies that are actively buying back their stock will increase/beat the market. However, in my 18 years in this business, I would say that there is a small benefit to a stock price from share buybacks. However, your question regarding repurchase programs and stock price is "cause and effect" and my favorite saying in statistics is, "Correlation does not equal causation!"

You could say that only companies that are generating a lot of free cash flow (FCF) from operations can afford to buy back their stock. It is PROVEN that companies that generate higher rates of FCF have stock prices that rise over time. As you can see, the buyback is likely just one piece of an overall bullish scenario. I think that you are looking in the right place, but the buyback is probably only a small part of the overall positive story.

Thanks,
Robb

* NOTE: Some original wording has been modified for legibility.