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Are stock buybacks helping or hurting the market?
It’s a question that was posed by my colleague Bob Ciura in Friday’s issue of Income & Prosperity. There’s no easy answer, but as Bob suggested, “Stock buybacks are a lot like fire. When used properly, they can perform valuable functions and serve a positive purpose. But when used improperly, it’s easy to lose control, and they can do a great deal of damage.”
At the end of last year, I touched on five companies that were doing buybacks the right way. Three of those five stocks – AutoZone (NYSE: AZO), AutoNation (NYSE: AN) and Lowe’s (NYSE: LOW) – were particularly aggressive buyers of their own stock. Each had reduced its shares outstanding by 33% or more for the preceding five years, and all three have outperformed the S&P 500 by 60 to 160 percentage points over the last five years.
The beauty of those companies is that they operate in non-capital intensive industries, meaning they don’t have to worry about using excessive cash for new manufacturing equipment or geographical expansion.
Well, I’ve dug deep again to find three more stocks that are aggressive cannibals of their own stock. And while some big names have made significant commitments to buy back stock, I’d rather own shares of a company that has a history of buybacks.
For example, 21st Century Fox (NYSE: FOX) has put a $5.8 billion buyback plan in place, but there is gross uncertainty in the media industry, so I’d rather see them hold on to that money and potentially invest it in becoming more digitally focused.
Same goes for Gilead Sciences (NYSE: GLD), which has a $7.9 billion buyback plan in place, but the pharmaceutical industry is becoming increasingly competitive.
As you can see, there’s a lot of noise to sort through when it comes to buybacks. Nearly three-quarters of S&P 500 companies are buying back their shares, but here are the top three buyback stocks that are making smart repurchases right now:
No. 1: TJX Companies (NYSE: TJX)
Discount retailer TJX is generating returns on invested capital of 38% – right there with the buyback champion AutoZone. TJX has also managed to reduce its shares outstanding by 14% over the last five years and has a current buyback yield (share buybacks over the last 12 months divided by market cap) of 3.2%.
TJX’s off-price retail model has helped it generate strong free cash flow across various economic cycles. It also already has an international presence that helps smooth out any geographical-specific economic hiccups.
No. 2: Travelers Companies (NYSE: TRV)
Travelers has an impressive 9.9% buyback yield and has managed to reduce its shares outstanding by 28% over the last half decade. Travelers’ commercial insurance business provides it with a steady flow of cash from premiums. It has doubled its international premiums over the last couple years, helping reveal a key growth opportunity.
Travelers has also been a steward of capital preservation, with more than half its investment portfolio in conservative municipal bonds.
No. 3: Dollar General (NYSE: DG)
Over the last five years Dollar General has reduced its shares outstanding by 24% and has a 3.5% buyback yield. It also sports a hefty 17.5% return on invested capital.
As the largest dollar store operator in the U.S., Dollar General has a large footprint to support cash flow for buybacks. Plus, it’s relatively cheap for the company to open new stores, given the rural markets it targets and its small-store format.
Ultimately, some buybacks are ill-advised and a waste of shareholder capital. Especially if those companies should be reinvesting that cash back into the business to maintain equipment or keep pace with competitors.
Having a strong market position and operating in an industry that doesn’t require large capital outlays – like the three companies above – is a big positive for buyback seekers.
Of course, those companies are far from the only ones wisely rewarding shareholders with buybacks. We’ve found several others that are so strong, you can hold on to them in perpetuity – no matter what the market is doing. Click here to find out more.