Renting a cottage isn’t all fun in the sun because some come with furry critters. I once stayed at a place on the edge of Georgian Bay that we affectionately called the mouse house. It was host to more than a dozen of the little beasts, which gnawed enthusiastically on the walls at night and noshed on our cheese.
Investors can learn a thing or two from the clever rodents, but instead of cheese, investors should focus on the cash that companies send to shareholders. Cash pays for dividends and stocks with generous dividend yields have done quite well. But I’m going to look at share repurchases today because companies that buy back their own stock tend to outperform over the long term.
Money manager Patrick O’Shaughnessy examined large U.S. stocks that repurchased their shares. He split them into two groups, a high-conviction and a low-conviction group. Stocks in the high-conviction group repurchased more than 5 per cent of their shares over the prior year, whereas the low-conviction group bought back a lesser percentage.
He formed model portfolios that tracked both groups from 1987 through 2014 using annual rebalancing and equal weighting. The high-conviction portfolio climbed at an average annual rate of 15.9 per cent over the period. The low-conviction portfolio grew by 12.2 per cent annually, while the large stock universe advanced by 11.2 per cent annually.
Stocks that repurchased their shares generally outperformed the market and the high-conviction portfolio beat it by an average of 4.7 percentage points annually. When Mr. O’Shaughnessy looked into the details, he found that the aggressive repurchasers usually bought their shares when they traded in the bottom third of the market based on a blended price-to-value score. In other words, they bought back, in bulk, at bargain prices, which is just the sort of thing value investors like to see.
The good results aren’t unique to the U.S. market. Mr. O’Shaughnessy’s team also looked at the situation in Canada, where they studied shareholder yield, which is a combination of buyback yield (percentage repurchased) and dividend yield. They found that the 10 per cent of stocks with the best shareholder yields gained an average of 13.9 per cent annually and outperformed the market by an average of 3.9 per cent from 1987 through 2013.
The findings inspired me to look for firms with high-conviction buybacks in the S&P/TSX Composite index using data from S&P Capital IQ. The accompanying table highlights the 18 stocks in the S&P/TSX Composite that reduced their share counts by more than 5 per cent over the past year.
Take the Power family of companies as an example. The firms recently held Dutch auctions to repurchase their shares. Power Corp. of Canada (POW) reduced its share count by 8.6 per cent over the past year, while its subsidiary Power Financial Corp. (PWF) cut its count by 7 per cent and its subsidiary Great-West Lifeco Inc. (GWO) slimmed its count by 6.1 per cent. The three also pay generous dividend yields of 5.8 per cent, 6.1 per cent and 5.4 per cent respectively. All of them trade at less than 10 times forward earnings based on industry analyst estimates for the next four quarters, which puts them in value territory. (Disclosure: I own shares of Power Corp. and Power Financial in my dividend portfolio, among others on this list.)
Firms that repurchase large fractions of their shares have fared well as a group, but there are of course individual disappointments. That’s why investors should keep a beady eye on what companies do with their money. Some firms repurchase shares at high prices while others pay unsustainable dividends and are likely to disappoint. But companies with sensible repurchase programs and dividend policies can offer up a nice bit of cash for investors to nosh on.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
Norman Rothery