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02/19/2018
Can you tell what stock buyback news is just noise and what really matters?
By: Ted Theodore
CAN YOU TELL WHAT STOCK BUYBACK NEWS IS JUST NOISE AND WHAT REALLY MATTERS?

What is a Stock Buyback?

Before we dive into the nuances, let’s first start with the basics. Stock buybacks, also known as share repurchases, are just one of the ways that companies can return wealth to their shareholders; the other more-common ways come in the form of capital appreciation—that is a rising stock price—and/or dividend payouts.

As the term implies, a stock buyback is simply the action of a company buying back its own shares.

How is this done?

Buybacks are carried out in one of two ways

1. Tender Offer: In this case the company will make an offer to repurchase a certain number of shares within a desired price range.

2. Open Market: In this case the company will act as an individual investor and buy its own shares on the open market.

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What is a Stock Buyback?

Before we dive into the nuances, let’s first start with the basics. Stock buybacks, also known as share repurchases, are just one of the ways that companies can return wealth to their shareholders; the other more-common ways come in the form of capital appreciation—that is a rising stock price—and/or dividend payouts.

As the term implies, a stock buyback is simply the action of a company buying back its own shares.

How is this done?

Buybacks are carried out in one of two ways

1. Tender Offer: In this case the company will make an offer to repurchase a certain number of shares within a desired price range.

2. Open Market: In this case the company will act as an individual investor and buy its own shares on the open market.

The result: the total number of shares outstanding is reduced and current investors end up owning a “larger piece of the whole pie”.

Buyback Announcements vs. Action

The misunderstandings start as soon as the buyback announcement is made. Plain and simple, all too many investors fail to make a distinction between a “buyback announcement” and an actual reduction in shares outstanding.

What does that mean exactly? Some investors will rush to buy a stock as soon as they catch whiff of a buyback announcement because they want to “own a larger piece from the whole” as mentioned previously. The problem is that they are only assuming that the buyback will take place.

The reality is that the company is under no legal obligation to follow through with their buyback announcement. Put another way, there is nothing set in stone that guarantees a buyback announcement will translate into an actual reduction in shares outstanding for a given stock.

While one would expect that management doesn’t make empty promises, the key nuance to buyback announcements is that they are just that—an announcement—and nothing more.

At TrimTabs Asset Management, we do not pay any attention to announcements. Instead, we focus on tracking actual reductions in the net shares outstanding.

Another Myth about Buybacks Busted

There is a pervasive belief that buybacks form a kind of cushion for the market. Investors who are fooled into believing this generally do so because their thought process goes as follows: the company won’t let its share price fall below a certain “floor level” because that’s where they are repurchasing shares at.

This couldn’t be further from reality.

What actually happens is that companies who have made buyback announcements will typically delay their repurchases when the overall market is declining, thinking if they wait a little longer, the cost of the buyback program might be reduced. Remember that there is no strict obligation that dictates when a buyback announcement must be carried out, and so the timing of the repurchase is left to the company, which effectively busts any “price cushion” myths.

Bottom Line

Investors can be easily misled by buyback announcements in the news. First and foremost, remember that a buyback announcement is not the same as an actual share repurchase; the former is just that, an announcement, and the company is under no legal obligation to follow through with that announcement. The surefire way to tell if management is keeping good on its buyback promise is to track actual reductions in the net shares outstanding.

Furthermore, because companies dictate the timing of their share repurchases, some might wrongfully assume that a buyback announcement will create a cushion for the share price. The reality is that companies will delay buybacks when the broad market is weak.

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