MONTHLY MARKET COMMENTARY

Transcription

1 MONTHLY MARKET COMMENTARY June 3, 2015 REVIEW May 31, 2015 December 31, 2014 % Change S&P/TSX 15, , % S&P 500 2, , % DJIA , % NASDAQ 5, , % 10 Yr. Cda Bonds 1.62% 1.79% -17 bp 10 Yr. US Bonds 2.12% 2.17% -5 bp 90 Day Cda T-Bills 0.63% 0.90% -27 bp 90 Day US T-Bills 0.01% 0.01% 0 bp US$ vs. Can$ $0.804 $ % STOCK BUYBACKS OR DIVIDEND INCREASES? US equity markets continued to rise as the S&P 500 and DJIA reached all time highs during the month. NASDAQ broke through its previous high last month. The previous high for NASDAQ was reached 15 years ago (March 2000). The Canadian market lagged the US for the month but is only 4% below its all time high reached last September. The Canadian Energy Sector has held the TSX from reaching new highs but we see encouraging signs as these companies are refinancing and adjusting their costs to the current price of oil. We remain optimistic the TSX will surpass its previous high later in the year. In this month s commentary we critique the benefits of corporate buybacks (share repurchases) and examine if this is beneficial to shareholders. In addition to this buyback strategy we compare it to another strategy; a strategy of dividend increases. Share Repurchases: Share buybacks allow companies to repurchase their own shares outstanding on the market. Corporations regularly file with security regulators their intention to buy back their shares, normally on an annual basis. Although this is a common occurrence many corporations do not buy back their full allocated amount or some do not buy any of their shares. There are numerous reasons corporations repurchase their shares. Generally speaking, buybacks occur when corporations view their share price as being undervalued. Warren Buffet has written on the merits of buy backs. In his 2012 annual report he writes the following: repurchases is sensible for a company when its shares sell at a meaningful discount to conservatively calculated intrinsic value. Indeed, disciplined repurchases are the surest way to use funds intelligently: It s hard to go wrong when you re buying dollar bills for $0.80 or less.but never forget: In repurchase decisions, price is all-important. Value is destroyed when purchases are made above intrinsic value. Berkshire Hathaway Annual Report Macs Investment Research Montréal Québec Toronto London Page 1 of 5

2 Below we illustrate the most recent history of stock buybacks by S&P 500 companies. $700 $600 $500 $400 $300 $200 $100 $0 S&P 500 Stock Buybacks (US$ Billions) Source: Citigroup, May 2015 There are other reasons critics of share buybacks argue corporations buy back their shares. When a corporation purchases its shares the number of shares outstanding are reduced, which can lead to an increase in their earnings per share even if the total earnings are the same. Critics argue that an increase in the earnings per share in this case masks the true state of the company. Another argument is because executive compensation is normally tied to the increase/decrease in a company s earnings per share. Critics of stock buybacks argue self-interest (management self-interest) is one of the prime motives. In addition, every dollar used is one dollar that won t be invested in their own business and can limit the future growth of its earnings. The poster-child for critics is IBM (IBM-NYSE). From 2010 to the end of 2014 the company has spent more than $60 billion repurchasing its shares. Below we show the results of their share repurchase program. While critics of share buybacks have many valid points, the stock market generally rewards those companies that repurchase their shares. While the data for all S&P 500 companies that have done share buybacks is difficult to gather, Goldman Sachs (GS-NYSE) has created an index (cannot be purchased to our knowledge) of those S&P companies that have repurchased their shares. Below are the results. In order to compare the results we start at the end of 2004 and assign a value of $1 to both the S&P 500 and GSTHREPO Index. In general, those companies that buy back stocks are rewarded through a higher share price and have done better than the. 3Macs Investment Research Montréal Québec Toronto London Page 2 of 5

3 Figure 1 Rewarding Shareholders - Buybacks $2.70 Stock Repurchases Source: Bloomberg-GSTHREPO Index Dividend Increases: In today s low interest environment, investors are looking for alternatives to investing in fixed income securities. There are many securities, especially in Canada, whose dividend yield (current dividend divided by the company s share price) is in excess of fixed income yields. In addition, many companies regularly increase their dividends. While we are in favour of dividend increases we also recognize there are times it is in the best interest of the company to retain their earnings to reinvest in their business. Again we refer back to Warren Buffet s 2012 annual report talking about stock repurchases and dividend increases: A profitable company can allocate its earnings in various ways (which are not mutually exclusive). A company s management should first examine reinvestment possibilities offered by its current business projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors. Berkshire Hathaway Annual Report 2012 Below we show a strategy (Figure 2) composed of companies that analysts expect will increase their dividends in the coming year and have a dividend yield above the S&P 500. As one can see, investing in those companies has not only done better than the S&P 500 Index but also greater than those companies that only repurchased their shares (Figure 1). 3Macs Investment Research Montréal Québec Toronto London Page 3 of 5

4 Figure 2 Rewarding Shareholders - Dividend Increases $2.87 Dividend Growth Source: Bloomberg-GSTHDIVG Index Dividend Increases and Stock Buybacks: The last group we focus on are those companies that analysts expect a dividend increase and have repurchased their shares. As one can see below, corporations that do both have the greatest return, though only marginally better than those companies that increase their dividends (Figure 2). Figure 3 Rewarding Shareholders - Dividend Increases and Buy-Backs $2.92 Dividend Growth and Repurchases Source: Bloomberg-GSTHCASH Index 3Macs Investment Research Montréal Québec Toronto London Page 4 of 5

5 Conclusion: There are critics that argue against stock buybacks, but we feel it is a legitimate way to reward shareholders provided they are done for the right reason(s) and properly implemented. Companies that are relatively mature and require little in the way of capital expenditures to maintain or grow their businesses come to mind. Having too much cash and not buying back their shares or increasing their dividends can also be dangerous. There are many instances companies spend their excess cash on projects they felt were useful at the time but ended up with dismal returns and paying out the cash would have been the correct course of action. Despite the additional benefit of stock buybacks and dividend increases (Figure 3) we favour the simple strategy of dividend increases (Figure 2) as we feel it is much easier to implement and less prone to errors and we have found few corporations that are consistently good at buying back their shares. As the bar graph on page two illustrates, stock buybacks reached their height in 2007, just before the financial crisis and reached the lowest point in 2009 when the stock market reached a bottom. Ian Nakamoto Director of Research 3Macs Investment Research Montréal Québec Toronto London Page 5 of 5