Morgan Stanley Research claims buyback delivers alpha but a closer look shows that it is all random and returns are highly skewed. Not all buybacks work and finding the winner is as good as a coin toss
Morgan Stanley Research (Asia/Pacific), in a recent report, has estimated that since 2005 investors have got as much as 73% excess returns over Sensex. However, this figure looks misleading because only 67 stocks out of 125 were able to outperform the Sensex. This would imply that much of the 73% outperformance over Sensex is due to the skewed nature of returns towards the few stocks which have truly outperformed by a large margin. For instance the 271% was the best return while on the other extreme it was minus 67%.
The report does not mention which stocks have performed well and which haven’t and whether there is anyway to select these in advance. Further, Morgan Stanley Research claims that “Buyback plus positive change in fundamentals is the recipe for excess returns. The top decile of performers produced a surplus return of 73% over 12 months.” However, the average returns over Sensex, of all the buybacks was found to be 14% over 12 months, while the worst performers (bottom decile) saw them underperform the Sensex to the tune of 38%.
Morgan Stanley analysed 125 companies and found out that half of the companies involved in buybacks have outperformed the Sensex over the 12-month period after the start of their buybacks. This is as good as a coin toss. If this is the case, finding those companies generating positive returns well in advance, that too with stupendous returns is would be anybody’s guess.
One of the more interesting patterns that Morgan Stanley Research has found out is that the start of the repurchase is more important to returns than mere announcement of the programme and that the average returns (absolute and relative) improve as buyback progresses—but market outperformance comes only after 12 months have passed following the buyback notice. In other words, investors should not expect immediate results and are advised to wait towards the end of 12 months or so. This is easier said than done. The report said, “Median outperformance is statistically insignificant until the passage of 12 months after commencement of the buyback. In any case, buyback yield excess returns only in a 12-month period—there is no short term benefit.” The median return was found to be just 5% excess performance over 12 months. You might as well invest in an index fund and not worry at all whether the buyback will succeed or not.
Some of the companies which have recently announced buybacks are Reliance Industries (RIL), Zee Entertainment and Indiabulls Real Estate.
Consider RIL, the biggest of them all. We had written about Reliance buyback before (http://www.moneylife.in/article/reliance-share-buyback-what-the-market-remembers/23058.html
). Reliance buyback has clearly not worked. In fact, it has given negative returns of 10% since it started its buyback programme on 1 February 2012. At that time, the price was Rs830 per share. It had bought back only Rs2,512 crore, or nearly one-fourth of the total amount up to 13 July 2012. The buyback price was Rs870 per share, which is to be completed by 19 January 2013. The total value of the buyback is Rs10,440 crore, one of the biggest in India. Usually buyback programmes are accretive and climb up slowly. But the scrip is currently quoting at Rs784.40.
Share buybacks is one of the strategies used by companies to realise their “true value”, especially if the owners or promoters think that their company is undervalued and a weak market could be an opportunity to buy back at cheap valuations. This is also done during times where excess cash is lying idle and there is no scope for increasing capital expenditures (capex) due to the nature of demand which can be low and weak. Thus, when the markets are moving sideways, a company can resort to buybacks as one of the strategies for boosting shareholders’ return. The report states, “Apart from being a tool to return cash to shareholders, buybacks are used by controlling stakeholders to raise their stakes and to signal management’s view of the likely return on share prices.
The report by Morgan Stanley Research seems to give the investor an impression that buybacks work. Some do but the trick is finding those winners. You might as well toss a coin.