U.S. companies increasingly buying back shares

U.S. companies have ramped up their share buyback activity for the third quarter in a row.

According to data from S&P, stock repurchases by components in the S&P 500 index totaled $55.26-billion in the first quarter of 2010, a 15.6% jump from the fourth quarter of 2009; and a 79.5% spike from the year-ago first quarter.

“Companies have officially returned to the buyback market; however their purchases appear to be aimed at neutralizing employee options, and are therefore preventing earnings dilution,” says Howard Silverblatt, Senior Index Analyst at S&P Indices.
“Given the record amount of cash on their books, we expect the S&P 500 companies to continue this strategy, even if the market picks up from the current correction mode and puts more options in the money.”

Silverblatt noted that normally he uses a year-over-year figure, “and in this case it’s a better headline), but in the current recovery we need to compare quarter-to-quarter to better measure the progress.”

However, the current buyback figure remains 67.9% below pales the all-time high; when $171.95-billion in shares were repurchased in the third quarter of 2007. Since that time, the quarterly magnitude of buybacks steadily decreased until bottoming out in the second quarter of 2009, when only $24.20-billion shares were repurchased. The figure has climbed since this juncture.

Moreover, a greater number of companies are buying back their stock on the open market.

As a whole, 251 companies in the index enacted share buybacks in the first quarter, up from 214 issues in the fourth quarter of 2009, 195 in third quarter of 2009, and 169 in the second quarter of 2009.

Although there was wider participation, buybacks remained concentrated; with only 20 companies accounting for nearly 60% of the buyback activity.

With respect to sector, Information Technology continues to dominate the buyback market, with 29.3% of all repurchases in the quarter. Telecommunications and Utilities were the only sectors to
decrease buyback activity quarter-to-quarter.

“Most companies still appear to be matching their buybacks with their option expiration in order to limit earnings dilution,” Silverblatt said.

If the market continues to recover, Silverblatt expects 2010 total buybacks to amount to about $245-billion. If the current correction degenerates into a bear market, “buybacks should slightly decrease as options move out of the money.”

Exxon Mobil (XOM), the long-term buyback champ, slightly increased its first quarter buyback activity ($2.50 billion from $2.37 billion), but remains 68.2% below its expenditures from a year ago ($7.85 billion).

IBM (IBM) spent the most on share buybacks during the first quarter ($4.02 billion), increasing its year-over-year quarterly repurchases by 128% (from $1.77 billion).

“Obviously, a greater number of companies are confident about their near-term future and have a strong enough cash position and secure enough cash flow to buy back their shares now at prices they feel are reasonable,” said Howard Kornblue, senior portfolio manager, Alpha Fiduciary Wealth Management, Phoenix.
“It's also a very good way to increase a stock's earnings per share figure by reducing the number of shares outstanding.”

Kornblue noted that a robust share buyback activity reflects a generally healthy underlying market – but there are exceptions. For instance, the aforementioned all-time highest buyback amount (in third quarter 2007) coincided with a market top that preceded a lengthy bear market.

“That was probably an unusual once-in-a-lifetime confluence of events,” he noted.

Share buybacks have a dark side too – they may simply indicate that a company can think of no other capital investments that might generate more worthwhile returns. Indeed, while repurchasing one's own shares can immediately boost the stock price, there's no guarantee that pouring money into a new project or R&D will yield any profits at all.

For all of 2010, Silverblatt added, he sees buyback growth and expenditures “outpacing dividends throughout the year, but remaining well below the record pace set in 2007.”