Do Stock Buyback Programs Work?

You’ve seen it dozens of time this year, the “Normal Course Issuer Bid” press release. When management decides their share price is so devalued that the best use of company cash is to buy its own stock, should you be buying too? Caseridge Capital’s Adam Adamou looks at the performance of these companies this year.

Do Stock Buyback Programs Work?
by Adam Adamou, Caseridge Capital Corp.

Many small to medium capitalization TechSys companies often ask us for advice on
whether they should initiate open market stock buyback programs, usually in the
belief that their shares are undervalued and that such a program will result in a
larger increase in their share price over time. Our response is typically as
follows: “stock buybacks don’t work for small caps, save your money and use it to
grow your business, and in any case, most of the companies that initiate stock
buyback programs do not follow through with much in the way of stock buying”. Don’t
get me wrong, they announce the buyback, they just don’t follow through with the
buying part. Institutional investors have learned over the years to ignore these
announcements as the typical yelp from disgruntled management groups looking for
attention.

And yet, they outperform.

Over the last twelve months, TechSys sector companies
that initiated stock buyback programs have gained an average of 67% (on an equal
weighted basis) vs. the S&P/TSX 60 Index which gained increased by 19% – more than
triple the gain, even though gross, EBITDA, earnings and net income margins have
been lower than the Canadian big cap index. This is important in that while the
multiples for the Buyback group are lower, the margins are also lower and by the
wisdom of our GMM model, lower margins should result in a stock underperforming over
time.
Comparing this Buyback group to some broader market indices, we were once again
surprised by the results:

The Buyback group has outperformed the 250 company Caseridge TechSys index by almost
10% over the last year, even as it presently trades at lower revenue. EBITDA and P/E
multiples. When compared to larger indexes, there really is no comparison, with
both the TSX 60 company large cap index and the TSX 300 company broader index
substantially underperforming. Even the Russell 2000 index – considered an
excellent proxy for the US mid-cap sectors, has been left in the dust by the Buyback
group, up “only” 26% over the last year even as it trades at twice the present
revenue and EBITDA multiples of the TechSys Buyback group.

The numbers are impressive. We do maintain however that the actual “buying” of
stock by companies that announce stock buybacks is rather skimpy, often resulting in
no decrease in the number of shares outstanding over the period that the program is
in place. Rather than indicating that a stock buyback program results in and of
itself in the shares of the target company outperforming, it may instead indicate
that management teams and Boards are excellent stock pickers, particularly when it
comes to their own shares.

With the present data group going back only one year, it is possible that these
figures represent an anomaly rather than the result of a market inefficiency that
might be exploited by investors looking to realize above average returns. We intend
to further explore this going back five and perhaps ten years, and we will add an
“insider buying” and an “insider selling” control group as well to see how these
control groups compare to the Buyback and the TechSys groups. At the very least,
this exercise is leading us to hesitate before we write off an announcement of a
“stock buyback” as being irrelevant to a company’s future stock price performance.

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We hope that you enjoy this weeks’ Caseridge TechSys DealBook.