Over the past few years, I have observed the different ways that companies conduct their share buybacks. This made me realise that the way a company conducts its share buybacks can have a profound impact on the long term returns of its stock.
Here are some share buyback strategies and what they mean for shareholders.
Opportunistic
The best way to conduct share buybacks is what I term as opportunistic buybacks. This means buying back shares aggressively when shares are undervalued and vice versa.
An example of a company that does this very well is the US-listed company Medpace, which helps drugmakers run drug trials.
In 2022, when markets and its own stock price were down, Medpace took the opportunity to buy back its shares aggressively. The company tapped the debt markets to procure more capital to buyback shares, to the extent that its net-cash position of US$314 million at the end of 2021 flipped to a net-debt position of US$361 million as of 30 June 2022.
But as its stock price went up, Medpace became less enthusiastic about buying back shares and instead started to pay off the debt it incurred; the company ended 2022 with a lower net-debt position of US$180 million
This type of opportunistic buyback strategy is the most efficient buyback strategy in my opinion.
The plot below shows the amount spent by Medpace on buy backs over the last 3 years.
With its stock price now at a much higher level, Medpace has not conducted buybacks for the last four quarters. Medpace’s management team is likely waiting for its shares to fall to a lower valuation before they conduct buybacks again.
Regular buybacks
Another way to conduct buybacks is to do it on a regular basis. The parent of Google, Alphabet, is one such company that has conducted very regular buybacks. In the past 10 quarters, Alphabet has consistently spent close to US$15 billion a quarter on buybacks. This includes quarters when the company’s free cash flow was less than US$15 billion.
Although I prefer opportunistic buybacks, regular buybacks may be best suited for a company such as Alphabet which has to deploy large amounts of capital. Alphabet’s shares have also consistently traded at a reasonable valuation over the last few years, making regular buybacks a decent strategy.
The chart below shows the amount that Alphabet spent on buybacks in each quarter for the last 10 quarters.
Poor timing
At the other end of the spectrum, some companies try to time their buybacks but end up being aggressive with buybacks at the wrong time.
Take Adobe, the owner of Photoshop, for example.
Adobe seems to change the level of aggressiveness in its share buybacks from quarter to quarter.
In the first quarter of 2022 , Adobe’s stock price was close to all-time highs, but the company was very aggressive with buybacks and spent more than US$2 billion – or 143% of its free cash flow in the quarter – to repurchase its shares.
When its stock price started falling later that year, instead of taking advantage of the lower price, Adobe surprisingly cut down on its buybacks to slightly over US$1 billion a quarter, less than what it generated in free cash flow during those periods. So far in 2024, Adobe has again increased its buybacks after its stock price increased.
The optimum strategy would have been to do more buybacks when its stock price was low and less buybacks when its stock price was high.
Bottom line
Buybacks can be a great way to add value to shareholders. However, it is vital that companies conduct buybacks at low valuations to maximise the use of their capital to generate long term returns for shareholders.
Medpace is an excellent example of great capital allocation, even going so far as to tap the debt markets to be even more aggressive with buybacks when its stock price is low. In the middle, we have companies such as Alphabet that consistently buyback shares. But on the other end of the spectrum is Adobe that seems to become more aggressive with buybacks at the wrong times.
Hopefully, more companies can follow in the footsteps of Medpace and make sure they put their capital to use only when the time is right.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Adobe, Alphabet, and Medpace. Holdings are subject to change at any time.