DEFINITION of Buyback Ratio
The buyback ratio of the amount of cash paid by a company for buying back its common shares over the past year, divided by its market capitalization at the beginning of the buyback period. The buyback ratio enables comparison of the potential impact of repurchases across different companies. It is also a good indicator of a company’s ability to return value to its shareholders, since companies that engage in regular buybacks have historically outperformed the broad market. Buybacks shrink a company’s outstanding share float, which improves earnings and cash flow per share, and have the advantage over dividends of offering management greater flexibility in timing.
BREAKING DOWN Buyback Ratio
For example, Company A may have spent $100 million on buying back its common shares over the last 12 months, and may have had a market capitalization of $2.5 billion at the beginning of this period, in which case its buyback ratio would be 4%. If Company B spent $500 million on buying back its shares over the same period, and had a market cap of $20 billion, its buyback ratio is 2.5%. Company A has the higher buyback ratio despite spending only a fifth of the amount expended on share repurchases by Company B, because of its much lower market cap.
Investors can invest in companies that engage in regular buybacks through indexes like the S&P 500 Buyback Index and exchange-traded funds such as the PowerShares Buyback Achievers Portfolio, the largest one in the buyback category. The S&P 500 Buyback Index includes the top 100 companies in the S&P 500 with the highest buyback ratios over the past 12 months, while the PowerShares ETF tracks the performance of U.S. companies that have repurchased at least 5% of their outstanding shares over the past 12 months. The S&P 500 Buyback Index has shown that it can consistently outperform the broader S&P 500 index over stretches of time.