When it comes to individual companies, many experienced investors often favor companies that repurchase their own shares. There are two reasons for this. One, managements on the whole often make poor capital-allocation decisions, such as overpaying for other businesses, or expanding near the peak of the business cycle. Many investors would prefer that especially for mature businesses, managements would use surplus cash not to expand operations or acquire other businesses, but instead increase dividends or purchase the company's own shares on the stock market (thus reducing the number of shares outstanding and increasing earnings per share). Two, a large buyback program can provide additional demand for a company's stock and help to drive its price higher.
But are large share buybacks across the market good for stock prices? The record is mixed.
Since the dividend payout ratio for the major indexes has been historically low, along with the dividend yield, many Wall Street strategists have argued that large share buybacks should be counted as dividends, because companies are supposedly returning cash to shareholders they way they do with dividend payments. The dividend yield on the S & P 500 Index, for example, has been at 2% or less for much of the last decade, which is about half its long-term norm of nearly 4%.
Adding the cash spent by companies on share buybacks to the amounts paid in dividends produces a new number, "net shareholder payout," which is now about 4.5%. That looks much better than 2%, doesn't it (especially when government bonds yield only 1.6% to 2.8%)?
There are two problems with this argument. One, cash spent on shares bought on the open market provide no additional cash to shareholders who continue to hold the stock. It is even questionable whether the buyback program drives the stock higher, depending on the size of the buyback relative to the average daily volume of shares traded in that stock.
Two, periods of high buyback activity have tended to coincide with market peaks, as managements are often most optimistic about their stock when the economy is strong and share prices have already risen sharply. Net shareholder yield peaked at close to 6% in 2007-2008, which was soon followed by a decline in the S & P 500 Index of more than 50%. The net yield hit on the S & P 500 bottomed at the market bottom, early in 2009. (This was probably because financial companies, particularly banks, issued massive amounts of stock in 2009.)
So while share buybacks for individual companies can still be a positive sign for its stock (when done my astute, shareholder-friendly managements), remember that it is not necessarily favorable for the market as a whole.