Corporations are buying back stock: Why you should care…

In a bearish market, investors often grapple with whether to buy, sell, or hold. Those considering allocating money now may find investing in energy and bonds attractive (think Treasury ETFs).

Slumping markets may hold another opportunity for investors seeking value: corporate stock buybacks. 

A stock buyback primer 

Dipping stock prices allow corporations with cash on hand to buy back shares of their own stock – offering a buying opportunity for value-minded investors. The appeal of a buyback lies in scarcity or supply and demand. When a company’s stock price has declined, a corporation may buy back its shares to reduce the float, or the number of shares in the market. This can create better conditions for its stock price to tick up later when demand increases.

Some corporations institute buybacks when they believe their stock is undervalued. Case in point, industry giant Warren Buffett often buys back shares in his own company, Berkshire Hathaway Inc. (BRK.A, BRK.B) for this reason. 

Know before you buy

 Buybacks can be an attractive down-market investment for companies, shareholders, and value-minded investors. But investors should understand that a buyback can improve a company’s position on paper without actually changing its fundamentals. Share repurchases tend to decrease the price-to-earnings ratio or P/E, making the company appear stronger or a better value than before the buyback. That’s because buybacks reduce the number of shares available, so they lower the P/E ratio merely as a function of the math – not because the company actually increased revenue or earnings.

When stocks go down, buybacks tick up 

With increasingly unstable markets this year, buybacks have blown past estimates. Per S&P analyst Howard Silverblatt, “buybacks hit a record $281 billion” in Q1’22 when the S&P 500 posted its largest quarterly loss in two years.

Corporations are also responding to the Inflation Reduction Act of 2022 (H.R. 5376). Effective in 2023 public company stock buybacks will be subject to a 1% excise tax. Thus, corporations may buy more of their stock now – before the 2023 tax change – to reduce float and potentially boost stock prices. If many corporations invest in their own stock, prices may rally later.

What to look for when considering buybacks

The ideal candidate for a corporate stock buyback should be a company with ample cash to invest and a low or declining Debt/EBITDA (earnings before interest, taxes, depreciation and amortization) ratio. A declining Debt/EBITDA ratio implies the company is paying off its debt and/or growing earnings, whereas an increasing Debt/EBITDA ratio means the company is taking on more debt but may not be seeing profits grow accordingly.

Even in downturns, consumers always need certain items – pharmaceuticals, energy, and low-cost consumer goods. Companies that provide those items typically fare well during a lagging market.

Considering buyback opportunities, here are a few stocks worth evaluating further:

• Energy firm Marathon Oil (MRO) has a Debt/EBITDA ratio below 1, which is attractively low for companies in the energy sector.
• Consumer goods giant Home Depot (HD) offers investors a decent Debt/EBITDA ratio hovering above 1 with an appetite for buybacks.
• Dollar General (DG), on the other hand, has a higher Debt/EBITDA ratio and recently authorized a $2B share repurchase. We included it on this list, however, because as a retailer of low-ticket consumer goods, DG could be interesting in these troubled times.
• Tech giant Apple (AAPL) topped all companies market-wide with its Q1’22 buybacks of nearly $23B and a Debt/EBITDA ratio of around 1. 

Other market-embattled Big Tech companies also executed buybacks. In 2021, Meta Platforms (META) purchased nearly $45B of its stock. In Q1’22 alone, META repurchased $9.4B and seems positioned for more. Microsoft (MSFT) took fourth place for buybacks market-wide with $7.8B – its largest buyback ever.

The bottom line 

Turbulent markets can cause a “flight to quality” as investors reduce risks in their portfolios. In this market, corporate stock buybacks are on the rise, and those companies may offer value to investors who wish to allocate capital now. Observing where corporations invest cash can be useful to investors seeking to weather downturns and find potential for future payback.

Brian Overby
Senior Markets Strategist for Ally Invest

As senior markets strategist for Ally Invest, Brian Overby is a widely sought-after resource for his option trading knowledge and market insights. He has contributed to numerous articles for the Wall Street Journal, Reuters, and Bloomberg, and has had frequent appearances on CNBC Fast Money and Fox Business News. A veteran of the financial industry since 1992, Brian continually seeks to improve the understanding of the retail investor. He has given thousands of option trading seminars worldwide, written hundreds of articles on investing, and is the author of the popular trading resource The Options Playbook and its free, acclaimed companion site OptionsPlaybook.com. Prior to Ally, Brian was a senior staff instructor for the Chicago Board Options Exchange (CBOE) and managed the training department for one of the world’s largest market makers, Knight Trading Group.