What Is a Buyback Ratio?
The buyback ratio is 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 analysts to compare the potential impact of repurchases across different companies.
The ratio is also a solid 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. Furthermore, buybacks have the advantage over dividends in that they offer management greater flexibility with their time-tables.
Buyback Ratios Explained
As an example of a buyback ration, consider the following scenario. Company ABC spends $100 million on buying back its common shares over the last 12 months. They have a market capitalization of $2.5 billion at the beginning of this period—in which case, its buyback ratio would be 4%.
On the other hand, if Company XYZ spent $500 million on buying back its shares over the same period and had a market cap of $20 billion, its buyback ratio would consequently be 2.5%. Company ABC thus has the higher buyback ratio—despite spending only a fifth of the amount expended on share repurchases by Company XYZ because of its much lower market cap.
[Important: Buybacks tend to peak when the markets are thriving, and they tend to slow down during bear markets, suggesting that investment managers do not excel at timing the market.]
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, which is the largest buyback fund in this 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.
A Closer Look at the Advantages
The share buyback program can be conducted for a prolonged period of time. This differentiates them from dividends, which legally must be paid to investors immediately. Furthermore, companies are under no obligation to offer such repurchasing programs, and those that do can modify or cancel the program at any period of time.
- The buyback ratio is a value that indicates 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.
- Buybacks shrink a company’s outstanding share float, which improves earnings and cash flow per share.
- Investors can invest in companies that engage in regular buybacks through indexes like the S&P 500 Buyback Index and exchange-traded funds.
Even more so, shareholders are not compelled to sell back the shares. They may do so, at will, but it is not a requirement imposed upon them. And from a tax consideration, buyback shares are taxed as capital gains, so in some cases, investors might favor buybacks over dividends in certain countries.