The “shrink float” exchange traded fund’s policy does not go after companies buying back stock with debt, which do not have good cash flows. They only target “the good buybacks,” in which companies are managing to shrink the overall share float.
The ETF strategy looks at three key driving forces behind buybacks. First, the shrinking float stocks imply that the stock is undervalued. These also play a role in corporate payout policy and are more tax efficient. Lastly, these buybacks offset share dilution from stock options.
Minyi Chen gave 24/7 Wall St. his three top picks in the current buyback universe that are the favorites right now. They were Walt Disney Co. (NYSE: DIS), Viacom Inc. (NASDAQ: VIAB) and Phillips 66 (NYSE: PSX).
Chen told us that the buybacks are likely to keep outperforming dividends, especially if interest rates rise too much — particularly with close two-thirds of S&P 500 shareholder return allocations going to buybacks and one-third close.
24/7 Wall St. asked Mr. Chen what his one best thing to convey to investors is regarding buybacks, which most investors do not usually consider.
The most important thing in buybacks that investors need to know is that the buybacks that matter are the ones where the float is truly shrinking. For instance, companies that are buying back stock but who have large numbers of shares being sold by executives and employees via stock options are not usually considered to be the best buybacks.
Mr. Chen’s comments are below:
With regards to Walt Disney Co. (NYSE: DIS):
Disney currently operates a buyback program made in March 2011. The repurchase authorization was 400 million shares. About 136 million shares remain unused as of February 2014, which is 7.7% of its total shares outstanding. Disney spent $4.1 billion on stock buybacks in 2013, up from $3.0 billion in 2012. The company has outperformed peers since Frozen’s release, and it has two upcoming Marvel films in 2014, followed by a major release of the Avengers sequel in 2015 and Star Wars VII in 2016. Disney has outperformed S&P 500 in four of the past five years.
On Viacom Inc. (NASDAQ: VIAB):
This company has an outsized buyback program compared to its market cap. In August 2013, VIAB increased its buyback program from $10 billion to $20 billion. Its spending on buybacks surged from $2.8 billion in 2012 to $4.8 billion in 2013. The remaining capacity under its buyback program as of February 2014 is $8.87 billion, which is 23% of its current market cap. In contrast, Apple’s $60 billion buyback program, which only has $18 billion left unused, equals to 3.8% of AAPL’s market cap. VIAB outperformed S&P 500 by 35% in 2013, and it has been outperforming for five consecutive years since 2009.
On Phillips 66 (NYSE: PSX):
Phillips 66 authorized additional share repurchases of $1 billion and $2 billion on July 30 and December 6, respectively. The combined $3 billion authorized is 6.7% of its market cap. ConocoPhillips spun this company off in May 2012 to give investors a pure play on its refineries. It is trading at 10-times estimated 2014 earnings, about the same as other independent refiners. However, unlike other refiners, the company’s management expects its non-refining businesses to grow to two-thirds of the firm’s value in four to five years. Phillip 66’s chemicals businesses, for example, contributed 20% of EBITDA last year. If the non-refining businesses can grow as expected, its stock should command a higher multiple.
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