The Speculator
We're buying 8
companies that buy themselves
We think it's a good sign when companies purchase
their own shares, because they know the real value within. Also: worrisome
signals from the VIX.
Everyone in every game, indeed every situation, has
a tried-and-true opening move they use when they need to get off to a good
start. In romance, business and friendship, it’s a good firm handshake and a
smile. In day trading, it’s “Buy the down opens, sell the rises -- and then be
nimble.” In checkers, it's Tom Wiswell’s “Old Faithful” move.
Tom has never lost with
that opening move (from square 11 to square 15, for those who really know the
game.). As he was world champion at checkers for a quarter-century, speculators
like us could do well to model trades on his example. We could go on about
tried-and-true moves, and we do below. But because getting to the point quickly
is the strong move in columns, we’ll tell you first that in stock trading, our
strong move is to buy S&P 500 ($INX) companies that buy back
their own stock.
Here’s a list of S&P 500 companies that have announced buybacks since
the end of November. We’ll be buying these to start the year.
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Buyback announcements |
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Since we wrote about buybacks in a series of columns last year, some
questions have come to mind. Would President Bush’s proposed elimination of the
dividend tax affect corporate incentives for repurchases? Why do buybacks lead
to better-than-average returns, anyway? And, most important, is the
out-performance likely to continue?
We asked David L. Ikenberry, who knows as much or more than anyone about
the subject. As an assistant professor at Rice University, he co-authored a
widely cited 1995 Journal of Financial Economics study with Joseph Lakonishok
and Theo Vermaelen. The study showed that buyback companies outperformed the
averages by 3 to 3.5 percentage points a year in the 1980s. An update for the
1990s showed even better results, with a difference of about 4.5 percentage
points a year.
Those results “may get stronger” if the dividend tax is cut or eliminated,
Ikenberry, now chairman of the finance department at the University of Illinois
in Champaign, told us in a telephone interview on Monday.
Ikenberry’s most recent work, to be published soon in the Journal of
Financial and Quantitative Analysis, finds that the biggest gains are in
companies that announce repurchases to signal confidence that their shares are
undervalued. If companies that repurchase shares as a substitute for paying
dividends are removed from the mix, buyback companies might do even better, on
average.
But don't buy blindly into buybacks, Ikenberry cautions. "Companies
use buybacks for several reasons, some of which are good and others which can
be neutral or perhaps misleading," he said. "Thus buybacks are not a
blanket signal to buy. They do however suggest that one might wish to dig a
little deeper as they may be indicative of underpricing."
Would he consider investing based on his finding? "Of course,"
he added. "I actually believe my own stuff."
Significant signals
Contrary to what you might assume, companies are not required to announce
buybacks in advance. Many share repurchases need not be reported except in the
quarterly or annual report, which can be months later.
Some companies, including Continental Airlines (CAL, news, msgs) and Microsoft (MSFT, news, msgs) have board authorizations
that would let them buy back the whole company without cluing in the public.
There’s no disclosure rule comparable to the one on insider purchases, which
says (as of September 2002) that an executive or officer must disclose a buy or
sell within 48 hours. (Editor's note: Microsoft owns MSN Money.)
Some chief executives may find the resulting opportunities for “painting
the tape” with share repurchases rather enticing. Moreover, some of the Enron (ENRNQ, news, msgs) hanky-panky involved
derivatives containing provisions for share buybacks at certain price levels.
The Securities and Exchange Commission is considering amending Rule 10(b)-18,
the so-called “Safe Harbor” for repurchases, to require more disclosure. But
the SEC has been rather busy lately.
Putting buybacks to the test
Disclosure issues aside, the big question remains, “Can you make money on
buybacks?” We like to put pencil to paper ourselves, being supporters of the
scientific principle that results, even those reported by Raelians, should be
reproducible.
Our initial study, reported in our April 18 column, took into account every company in the
S&P 500 that announced a buyback in 2000 and the first quarter of 2001.
There were 224 such companies. We then compared price appreciation over the 12
months from the close of the day after the announcement to the comparable move
in the S&P 500 itself.
The average superior performance was 30 percentage points, more than six
normal deviations from zero -- or a 1-in-100 million shot by chance alone.
Some of our other findings were surprising and controversial. We found,
for example, that stock performance wasn’t affected by a company’s failure to
complete an announced buyback. We surmised that the company had achieved its
goal of alerting the market that its shares were undervalued, making a buyback
unnecessary.
Our results led us to buy all 13 stocks that had announced buybacks to
date in 2002. The performance of this “Lucky 13” portfolio, from the column’s
publication on April 18, 2002, through Jan. 10, 2003, was -15.6%, more than 6
percentage points better than the S&P 500’s 22% decline. The group had to
contend with horrible slumps in Tenet Healthcare (THC, news, msgs) (-66%) and MGIC
Investment (MTG, news, msgs) (-43%). The biggest gains
were in Lexmark International (LXK, news, msgs), up 8.5%, and Aflac (AFL, news, msgs), up 4.7%.
Calculating the Lucky 13’s
return from the buyback-announcement date gives even better results: -3.8%, vs.
-16.7% for the S&P 500, a difference of 13 lucky percentage points. Final
results aren’t in yet, as only one of the stocks -- Bear Stearns -- has
completed a full year of performance since its buyback announcement.
This month, we extended our study with an enumeration of every buyback
announced by S&P 500 companies in 2002. We found 124 companies and compared
their price appreciation from the announcement day’s close through year-end
2002 vs. the comparable moves in the S&P 500 itself.
These 124 stocks outperformed the index by 6 percentage points. The result
is noteworthy, considering that the index’s performance would have been worse
if not for the buyback companies. Only 58% of them beat the market, but taking
variability into account, the average 2002 buyback company had a 95% chance of
beating the market by 4 to 8 percentage points.
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Buyback companies vs. the market, 2002 |
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The big winners were Yahoo (YHOO, news, msgs), EMC Corp. (EMC, news, msgs) and Principal Financial
Group (PFG, news, msgs), beating the S&P 500
from announcement date through year-end by 63%, 50% and 45%, respectively. The
big losers were Tenet Healthcare, -39%, King Pharmaceuticals (KG, news, msgs), -21%, and Concord EFS (CE, news, msgs), -20%.
A full workout of the 124 companies that announced buybacks in 2002 is
available at our Web site.
VIX-eye view
The performance of the S&P 500 so far in January has been extremely
good by relative standards, and by far the best in the past dozen years.
Usually at the beginning of the year the bulls and the bears battle for
ascendancy, so that the market can take the chips from those who are wrong. But
this year, it has been straight up, with rises on seven of the 10 days starting
with Dec. 30. That’s not as mischievous as the market mistress likes to be. In
addition, the CBOE Volatility Index ($VIX.X has moved from 50 on July
23 to 27 on Tuesday morning, very close to the 25% level that disturbs our
sense of ease about the market. After a move down from 50, we’d say that 30 is
low and neutral. Nevertheless, we plan to close out all our longs on the next
big up day or a move below 25 in the VIX, whichever comes first. We won’t go
short because that’s a losing strategy for us and everyone else we’ve ever met
in the market.
However, a contrary view comes from someone much more accurate and worthy
of note than ourselves -- someone we consider the greatest practical forecaster
of all time. Sam Eisenstadt, the research chairman of Value Line, writes: “Our
model, which attempts to predict the changes in the S&P 500 six months out,
includes free reserves (a measure of liquidity in the banking system), the
dividend yield, short term rates and other internal technical factors. The
outlook: about a 20% rise in the next six months.”
Final note
Our trading has benefited from lessons learned in other areas of life. We
therefore asked a few natural philosopher/traders for their tried-and-true
moves. Three appear below. A complete list is available on our Web site.
If you have a compliment, a critique, a complaint or a good
opening move, send
it to us by e-mail.
At
the time of publication, neither Victor Niederhoffer nor Laurel Kenner owned
any of the stocks mentioned in this column.