Larry Swedroe: Don’t Underestimate Buyback Power

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Random Walker
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Larry Swedroe: Don’t Underestimate Buyback Power

Post by Random Walker » Wed Apr 11, 2018 8:21 am

http://www.etf.com/sections/index-inves ... back-power

There are three ways a company can give money back to its investors: dividends, distributions from buyback of shares, and buyback resulting in the investor owning an increased proportion of the company. A famous paper by Miller and Modigliani showed that investors should be indifferent as to how they receive these distributions. (This is why it is a behavioral error to focus on dividend paying stocks). In this article Larry reviews a paper demonstrating that by ignoring buybacks, those who use the discount dividend model to estimate expected returns have been underestimating future returns. The discount dividend model uses current dividend yield and historic dividend growth, which can underestimate future returns. The authors suggest a total payout model That increases per share growth by adding in buybacks.

Dave

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nedsaid
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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by nedsaid » Sat Apr 14, 2018 11:19 am

Larry makes a good point here. The power of buybacks increasing Earnings Per Share and a shareholder's percentage stake in the company has been known for years though probably underappreciated by many investors. A couple of cautions, announced buybacks are not always followed through and the issuance of options and stock to employees can dilute this effect. Don't buy a company just because it announces a buyback, check and see if the outstanding shares have been decreasing over time.
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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by motorcyclesarecool » Sat Apr 14, 2018 12:44 pm

A “buyback yield” mutual fund could be really nice to have in taxable.
Understand that choosing an HDHP is very much a "red pill" approach. Most would rather pay higher premiums for a $20 copay per visit. They will think you weird for choosing an HSA.

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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by unclescrooge » Sat Apr 14, 2018 12:52 pm

motorcyclesarecool wrote:
Sat Apr 14, 2018 12:44 pm
A “buyback yield” mutual fund could be really nice to have in taxable.
There are several ETFs already, with slightly different twists.

PKW, SYLD, TTFS, TTAC

10% of my portfolio is in one of these.

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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by JoMoney » Sat Apr 14, 2018 2:27 pm

"Don't Underestimate" indeed... it's estimated that a large chunk of the >$2.5 trillion being held overseas might be repatriated thanks to the new tax policy.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by nisiprius » Sat Apr 14, 2018 2:40 pm

What he is saying in these two articles is not exactly contradictory, but still is an interesting contrast. In Look Beyond 60/40 Portfolio he says that future returns of stocks almost sure to be muted because of "valuations," and therefore you really ought to also invest in Stone Ridge alternatives funds. But here, in Don't Underestimate Buyback Power, he all but says that investors have, in fact, been underestimating buyback power, and therefore returns are likely to be higher than expected.

ADDED: Larry sent me a PM:
need to read more carefully my friend

The statement that you made saying I am saying returns are higher than expected is NOT what I said at all. Weird that you got that. In fact in one of the bullets I say the estimated return from the buyback model is as good as the CAPE 10, which is what is used in that model, so there is then no difference in the forecasted returns...

Best wishes
Larry
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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by Lauretta » Sun Apr 15, 2018 9:35 am

Interesting piece. Thank you for sharing (and Mr Swedroe for writing it).
I am currently travelling and somewhat jet-lagged, but I hope to read the original paper by Straehl and Ibbotson soon. For the moment I am wondering how this fits in with Jack Bogle's way of estimating future returs (somewhat related to the Gordon equation) which goes:
Future Market Returns = Dividend Yield + Earnings Growth per Share +/- Change in P/E Ratio
Any ideas/comments welcome :happy
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SimpleGift
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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by SimpleGift » Sun Apr 15, 2018 10:21 am

Lauretta wrote:
Sun Apr 15, 2018 9:35 am
For the moment I am wondering how this fits in with Jack Bogle's way of estimating future returs (somewhat related to the Gordon equation) which goes:
Future Market Returns = Dividend Yield + Earnings Growth per Share +/- Change in P/E Ratio
Any ideas/comments welcome
Just to point out that if one is using earnings growth per-share in Mr. Bogle's formula, then buybacks are already incorporated into it — since net buybacks are reducing the number of shares outstanding and increasing the growth rate of earnings-per-share.

This is addressed in the Ibbotson and Straehl paper, reviewed by Swedroe in the OP:
  • Image
Cordially, Todd

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Lauretta
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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by Lauretta » Sun Apr 15, 2018 11:46 am

SimpleGift wrote:
Sun Apr 15, 2018 10:21 am
Lauretta wrote:
Sun Apr 15, 2018 9:35 am
For the moment I am wondering how this fits in with Jack Bogle's way of estimating future returs (somewhat related to the Gordon equation) which goes:
Future Market Returns = Dividend Yield + Earnings Growth per Share +/- Change in P/E Ratio
Any ideas/comments welcome
Just to point out that if one is using earnings growth per-share in Mr. Bogle's formula, then buybacks are already incorporated into it — since net buybacks are reducing the number of shares outstanding and increasing the growth rate of earnings-per-share.

This is addressed in the Ibbotson and Straehl paper, reviewed by Swedroe in the OP:
  • Image
ok thanks. Yes I thought so, therefore one takeaway seems to be that if you use historical earning growth values in the Gordon model (as was mentioned in the thread I was resurrecting) you probably underestimate the true earning growth value which is now higher due to buybacks. Anyway will read the paper carefully.
I was a bit confused because increased buybacks decrease dividends, and i remember seeing a paper by Arnott and Asness from 2003 (I guess it was before they argued :wink: ) where they found empirically that Higher Dividends = Higher Earnings Growth. Though I think they were considering the situation where if you have less dividends the money was reinvested in the firm rather than used in buybacks.
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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by 3CT_Paddler » Sun Apr 15, 2018 12:07 pm

For a growing company I agree that it doesn't matter. Stock prices are always future looking - investors seem to care more about your next 6-12 month outlook vs your actual performance over the previous 12 months.

With dividends it's like taking money off the table. With a lower tax rate for corporations, I would hope that we see more companies issuing dividends. I don't buy that they are all totally equal methods of distribution. Buybacks are more speculative in my uneducated opinion.

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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by daveydoo » Sun Apr 15, 2018 12:45 pm

Bed Bath & Beyond, anyone? :D
"I mean, it's one banana, Michael...what could it cost? Ten dollars?"

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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by MrPotatoHead » Sun Apr 15, 2018 8:47 pm

daveydoo wrote:
Sun Apr 15, 2018 12:45 pm
Bed Bath & Beyond, anyone? :D
Are they still in business? I thought they went out with Carson's, Fields, Sears, K-Mart and Penny's. Well, maybe some of these are still in business and someone shops there. Kind of sad too as I shop local and not on the net but they have no presence in my area any longer.

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Re: Larry Swedroe: Don’t Underestimate Buyback Power

Post by Dead Man Walking » Mon Apr 16, 2018 9:54 pm

unclescrooge wrote:
Sat Apr 14, 2018 12:52 pm
motorcyclesarecool wrote:
Sat Apr 14, 2018 12:44 pm
A “buyback yield” mutual fund could be really nice to have in taxable.
There are several ETFs already, with slightly different twists.

PKW, SYLD, TTFS, TTAC

10% of my portfolio is in one of these.
Since I don't invest in ETFs, I had no idea that such ETFs existed. The proliferation of ETFs that track various factors may increase the number of behavioral errors that an investor may make. Larry Swedroe believes that chasing dividends is a behavioral error. As a mutual fund investor, I know that some of the stocks in my funds pay dividends; others do buybacks. My greatest behavioral error would be chasing total returns. Predicting expected returns is a fool's errand no matter what method one uses.

Thanks for sharing the list of funds.

DMW

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