Why Investors Can Only Benefit From Share Buybacks Through Large-Cap Companies

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From purely an armchair perspective, I've had trouble with financial engineering, because of the lack of social productivity attached to it. At least when Andrew Carnegie was done lashing the backs of Slavs and other unfortunate immigrants, we had Pittsburgh to show for it (by the way, I've written a book on immigration policy called Immigrants: Unleashing the Economic Force at Our Door, which argues in favor of immigrants and immigration).

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However, one financial slight of hand that I like offers patient investors a nifty opportunity. Specifically, today's low, low interest rates, which I believe will persist for the balance of the decade, making it feasible for companies to swap equity for very cheap debt. To wit, IBM (IBM) used the proceeds from a 2010 bond offering that paid a 1% yield to repurchase stock that paid a 2% yield at the time.

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The trend is large. In 2012, US companies spent over $400 billion to buy back their own shares. In the first quarter of 2013, US companies have announced over $120 billion in new share buybacks.

Despite the size of the buybacks of the trend, I believe investors can access the benefits only through large cap companies. Here's why.

First, access to cheap credit is not evenly distributed. For many smaller companies, credit can still be tight. Second, large cap companies are the most likely beneficiaries of the tailwind on equities in general.

While investors pulled some $124.7 billion from equity funds in 2012 and poured $535.2 billion into fixed income funds, the trend has started to turn around. More monies flowed into equities (mutual funds and ETFs) in the first quarter of 2013 than monies flowed into fixed income funds. Pervasive indexing, as well as the preponderance of large cap oriented fund products, suggests the McDonald's (MCD), the Wal-Marts (WMT) and the Johnson & Johnsons (JNJ) of the world will take up the slack first.

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Here's a list of companies that had share buybacks (and increased their dividends) within the last year according to Bloomberg data. All of these companies are owned by the GMG Defensive Beta Fund (MPDAX) which I co-manage, and most of which are held in separate accounts managed by our firm:

  • Exxon Mobil (XOM)
  • Johnson & Johnson (JNJ)
  • United Parcel Service (UPS)
  • CVS Caremark (CVS)
  • Wal-Mart (WMT)
  • Chevron (CVX)
  • Microsoft (MSFT)
  • Home Depot (HD)
Follow Oliver Pursche on Twitter: @opursche.

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