Companies have snapped up their own shares on the open market with increasing frequency in recent months. They do so for a variety of reasons, and investors have long used their actions as a signal to buy or sell shares on their own.
Believers in the buyback play offer a simple rationale:Who better than the firm’s own management would have a solid grasp of the company’s prospects in the competitive landscape and therefore its true value relative to its market price?
Others may view it obvious but still effective gimmickry aimed at goosing share prices by manufacturing higher earnings per share .
A pair of ETFs provide exposure to the buyback play, but they differ greatly despite their common strategy.
I’ll look briefly at each.
The PowerShares Buyback Achievers Portfolio (PKW) is the larger and more liquid of the two. Launched in 2006, PKW was the first mover here. It holds a healthy $230 million in assets and trades at decent 10 basis point spreads.
The fund holds U.S. firms that have repurchased sizable chunks—5 percent or more—of their outstanding shares over the past 12 months. Top holdings include familiar names like IBM, Intel, Home Depot and Disney.
In the aggregate, PKW’s basket of stocks differs from a plain-vanilla cap-weighted portfolio a whole lot less than you’d expect given its niche focus. Large-caps dominate the basket and sector exposure is marketlike except for a bias to consumer cyclical stocks.
Not surprisingly, PKW’s performance overall during the past year looks a lot like the broad market, which is to say, good.
The question then is, Why bother?
If performance and holdings aren’t a big step away from a cap-weighted fund, why choose PKW at 71 basis points a year over a dirt-cheap plain-vanilla offering?
One reason could be longer-term performance:PKW’s returns have beaten the broad market’s performance over three- and five-year periods.
A more compelling reason would be belief in the underlying strategy.
Among other reasons, firms repurchase shares if they don’t have internal growth opportunities. While returning cash is better than spending it poorly, buybacks signal a firm’s trend toward value on the style continuum, reinforced by a lower price/earnings ratio from higher earnings per share. In this respect, buybacks have as much to do with a firm’s life cycle as with management’s assessment of the stock’s current valuation.
For me, that’s academically interesting, but not enough to outweigh simply owning the market John Bogle-style.
The AdvisorShares TrimTabs Float Shrink ETF (TTFS) offers a more complex strategy selection, but investor’s haven’t bought in yet. The actively managed fund chooses firms based on a reduction in shares outstanding—hence the “float shrink” in the fund’s name—but also employs fundamental screens, namely free cash flow and leverage.
The fund’s portfolio heavily favors midcaps over large-caps, a departure from PKW and the broad market. TTFS’ performance record is decent but brief—the fund launched in October 2011.
Whether due to its newcomer status or a higher fee of 99 basis points compared with 71 basis points for PKW, investor interest is weak judging by low assets of $12 million and poor liquidity, as measured by spreads of 47 basis points. If TTFS’ more rigorous approach appeals to you, be sure to trade with care and monitor assets and news of fund closure.
Returning to a Bogle point of view, buybacks signal something else. If the share price doesn’t actually move following the buyback, the firm’s market footprint will shrink based on the smaller float, so cap-weighted funds will own less of them, not more.
At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at firstname.lastname@example.org .
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