The Failure of Stock Buybacks

An S&P study finds that amid record levels of share repurchases, most companies have not increased shareholder value

by Todd Rosenbluth and Stewart Glickman, CFA From Standard & Poor's Equity Research

The following is an excerpt from a report prepared by Standard & Poor's Equity Research

Share buyback activity by companies in the Standard & Poor's 500-stock index accelerated in the first half of 2007, reaching record-setting levels. The value of shares repurchased initially exceeded $100 billion for consecutive quarters ended December, 2005, and March, 2006, and it has continued to climb since then. Indeed, over the 18 months ended June 30, 2007, when the buyback bonanza showed signs of staying power, S&P 500 members spent more than $700 billion on stock repurchases.

During the six completed quarters ended June 30, 2007, 423 companies in the S&P 500 reported share repurchases, removing nearly 20 billion shares from the market. In general, taking debt leverage out of the equation, we contend that companies should engage in share repurchases only when they have strong cash flow and when internal projects are insufficient to generate a comparable rate of return.

Given the recent surge in buyback activity, we question whether the latter qualification is being properly taken into consideration. While these corporate actions appear to have been intended to be shareholder-friendly, there may have been more appropriate uses for the cash.

Data vs. Conventional Wisdom

Conventional wisdom holds that (1) stock prices go up as a result of buybacks, (2) more buybacks are better than fewer buybacks, and (3) announced share buybacks actually reduce the number of outstanding shares significantly.

Based on a study of buybacks conducted by S&P's Equity Research Services of the 18 months ended June 30, 2007, we believe that all three points were unsupported by the data during that period.

While analysis over a longer time frame may be warranted, we contend that shareholders need to more closely question buyback activities undertaken by corporations rather than applauding these decisions without closer examination.

We believe that while some S&P 500 companies have used buybacks judiciously, repurchasing at discounts to recent share prices, most companies have been too enthusiastic with their stock-buyback programs and have not increased shareholder value. While our 18-month study period was relatively narrow, the associated results have, in our view, broad implications.

Analyst Rosenbluth follows shares of telecommunications services companies for Standard & Poor's Equity Research Services . Analyst Glickman follows shares of oilfield-services companies for Standard & Poor's Equity Research Services .