By John Wasik
CHICAGO Dec 2 Public companies share the wealth
with shareholders in a number of ways. Sometimes they channel
profits into quarterly dividends. They can also buy back their
Corporations have been on a buyback binge in recent years.
S&P 500 companies purchased $118 billion of their stock in the
second quarter of this year, up 18 percent from the first
quarter, according to S&P Dow Jones Indices. (During the second
quarter of 2012, companies bought back $111 billion.)
Although the merits of buybacks are hotly debated among
analysts, they often can be beneficial for investors. A small
group of exchange-traded funds are capitalizing on this trend.
In a bull market, companies that buy their own stock on the
cheap can benefit when the overall market is rising.
One of the largest funds in this miniscule group is the
PowerShares Buyback Achievers Portfolio Exchange-Traded Fund
, with more than $2 billion in assets. The fund's
strategy of investing in mostly large-cap stocks that have
"effected a net reduction of shares outstanding of five percent
of more in the past 12 months" has paid off handsomely.
During the past year through Nov. 29, the fund has returned
about 42 percent, compared to the 30-percent gain by the S&P 500
Index. The fund, which charges 0.71 percent in annual expenses,
has beaten the index by five percentage points during the past
three- and five-year periods.
How has the PowerShares fund managed to best the S&P 500 by
such a wide margin? It has a slight tilt toward "value" stocks.
The average price-to-book value of its holdings is 1.8, compared
to 2.6 for the S&P 500. (The lower the price-to-book ratio, the
greater chance a stock is undervalued relative to the rest of
Stocks in the fund include ConocoPhillips, American
International Group and Viacom Inc.
A related strategy can be found in the AdvisorShares
TrimTabs Float Shrink ETF, up 38 percent for the annual
period through the end of the month. It's more expensive than
the PowerShares fund, at 0.99 percent in yearly expenses.
Like the PowerShares fund, the AdvisorShares portfolio holds
less well-known stocks, such as Corning Inc, McKesson
Corp and Parker-Hannifin Corp.
WILL BUYBACKS CONTINUE?
One of the reasons corporate treasurers find buybacks
attractive is rock-bottom interest rates enable them to finance
buying shares. Hamstrung by a slack economy that curtails hiring
and research and development spending, they can easily bolster
stock holdings by purchasing company shares in the open market.
Buyback announcements can also trigger a feeding frenzy.
Investors see a company buying its own shares and join the
bandwagon, thinking they, too, are getting a good deal. In a
rising market, that can help a stock price appreciate.
And since the funds involved in buybacks may be undervalued
relative to the larger market anyway, they may see more upside -
especially if they are less popular than the companies that
typically dominate stock-market indexes.
There's a problem that runs counter to the feedback effect,
though. What if corporate treasurers are buying at or near the
top of the market? Then they are not buying bargains, although
there's no way of telling until a downturn comes. All told, it's
difficult to tell whether this strategy is a long-term winner.
"I don't have good data to suggest it is good (or) bad for
shareholders," Todd Rosenbluth, director of ETF and mutual fund
research for S&P Capital IQ, said in an email. "We
looked at a point in time and found that often managements
bought shares back at levels that seemed too high, but since
then, of course, most stocks have climbed higher."
The buyback picture might change when the Federal Reserve
starts to throttle back its stimulus and raise interest rates.
Few know when that will happen, but it may dampen enthusiasm for
low-cost share financing.
At the very least, you should keep in mind that buyback
funds will probably work best in a bull market, yet are not
without risk. They won't insulate you from the bruising of a
stock selloff, nor are they inexpensive to own relative to
broad-market index funds.