Buyback Ratio - Explained
What is a Buyback Ratio?
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Table of ContentsWhat is a Buyback Ratio?How does a Buyback Ratio Work?Academic Research on Buyback Ratio
What is a Buyback Ratio?
Buyback ratio refers to the money that an organization pays to buy back its own common shares over the previous year divided by the market capitalization at the period when buyback starts. This ratio clearly helps in identifying and comparing the prospective effect of repurchase programs in several companies. Shareholders can also assess the ability of an organization to proffer returns on their investment in shares. Organizations that deal in buybacks constantly have a bigger impact on the market. The outstanding share float of an organization reduces when it buys back its shares, and this ultimately boosts its earnings and cash flow on an average. Also, this gives more time to the management team to decide and offer dividends to its shareholders.
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How does a Buyback Ratio Work?
For instance, company A that has incurred $100 million on its share buyback for a period of last 12 months with a market cap of $2.5 billion at the beginning of this time period will have a buyback ratio of 4%. Company B that incurred $500 million on its buyback, and had a market capitalization of $20 billion at the beginning will have a buyback ratio of 2.5%. Comparing the scenarios of both companies, company A has more buyback ratio as compared to company B, in spite of spending less, and going with a smaller market cap than the latter on its buyback. If investors want to invest in organizations that buyback shares on a regular basis, they can follow indices such as ETFs (exchange traded funds) and S&P 500 Buyback Index. PowerShares Buyback Achievers Portfolio is considered to the biggest ETF in the buyback category. The S&P 500 Buyback Index consists of the best 100 companies in the S&P 500 having the top buyback ratios in the last 1 year. On the other hand, the PowerShares ETF records how U.S. firms have performed over the past 1 year by repurchasing a minimum of 5% of their due or outstanding shares. The S&P 500 Buyback Index outweighs S&P 500 Index in terms of consistency over different time intervals.
Academic Research on Buyback Ratio
- The Buyback Anomaly on the Polish Capital Market, Szyszka, A., & Zaremba, A. (2011). Finanse, Rynki Finansowe, Ubezpieczenia, (38), 481-494. A number of studies carried on the US data found positive long-term excess returns following buybacks. The aim of this paper is to verify if a similar anomaly can be observed on the Polish market. We confirm the existence of long-term abnormal returns following buybacks and excess profitability of the buyback mimicking strategy (i.e. buying stocks after repurchase announcements). We discuss potential sources and present various interpretation of our evidence. Among others, we propose an alternative behavioral hypothesis for abnormal post-buyback returns. We show circumstances under which post-buyback outperformace might be also a result of managerial biases at the time of the repurchase and later temporal market overreaction in the post-buyback period.
- Buyback behavior of initial public offering firms, Chen, S. S., Ho, K. W., Huang, C. W., & Wang, Y. (2013). Journal of Banking & Finance,37(1), 32-42. We examine the motives behind the share repurchase decisions of initial public offering (IPO) firms by studying the stock and operating performance after the IPO date. We find that IPO firms that announce repurchases within 3years of IPO dates exhibit poorer long-run abnormal operating performance than other IPO firms. These IPO firms also experience poorer stock return performance and downward analyst forecast revisions. Moreover, these firms show intensive insider selling transactions after the IPO date. These results for IPO announcing repurchase firms are consistent with the misleading hypothesis, which suggests that these IPO firms mislead investors by announcing repurchases as false signals.
- Takeover deterrent effect of on-market share buyback in Australia, Doan, D. H. T., Yap, C. J., & Gannon, G. (2011). Australasian Accounting, Business and Finance Journal,5(4), 65-84. This study examines whether Australian firms use on-market share buybacks to deter unwanted takeover risk. We found a statistically significant and positive relationship between a firms ex-ante takeover probability and its on-market share buyback activities. Our result is robust to alternative modelling techniques, namely TOBIT and Censored Quantile Regressions. This paper found evidence that in a dividend imputation credit taxation system the yield of share buyback is positively related to dividend payments. However, on-market share buyback activity is closely related to temporary cash flows rather than to permanent operating cash flows. This might indicate that, besides dividend payments, Australian firms take advantage of the financial flexibility that comes with share buybacks to redistribute nonpermanent cash flows to their shareholders.
- The effect of managerial overconfidence on the market timing ability and post-buyback performance of open market repurchases, Chen, A., & Lu, C. S. (2015). The North American Journal of Economics and Finance,33, 234-251. This paper investigates whether managerial overconfidence has an adverse impact on the market timing ability and post-buyback performance of open market repurchases, and whether corporate governance can mitigate the adverse impact in Taiwan. We find that managerial overconfidence raises the repurchase cost implying an adverse impact on the market timing ability of share repurchases. The repurchasing firms with overconfident managers experience poorer short-run announcement return and long-run stock performance than those without overconfident managers because of the poorer market timing ability and the higher repurchase cost. However, corporate governance mitigates the adverse impacts of managerial overconfidence on the market timing ability and post-buyback performance of repurchases.
- Share Buyback and Firms' Performance: A Study of Selected Indian Companies, Gupta, M. Share Buyback and Firms' Performance: A Study of Selected Indian Companies.International Journal of Trend in Research and Development,3(4).
- Buyback Blackout Periods Do Not Negatively Impact Market Performance, Kaplanian, A. Buyback Blackout Periods Do Not Negatively Impact Market Performance.