What Is the S&P 500 Buyback Index?
The S&P 500 Buyback Index is an index designed to track the performance of the 100 S&P 500 stocks with the highest buyback ratios over the past 12 months. The S&P 500 Buyback Index is equal-weighted and rebalanced quarterly, with the rebalancing reference dates occurring on the last trading day of each calendar quarter. Index changes are effective after market close on the third Friday of the month after the reference date.
- The S&P 500 Buyback Index is designed to measure the performance of the top 100 stocks with the highest buyback ratios in the S&P 500.
- Companies buy back shares with retained earnings, bidding up the share price and reducing the stock of shares outstanding.
- Although criticized by some as artificially inflating stock prices and allocating cash inefficiently by firms, share buybacks have increased dramatically over the past decade.
Understanding the S&P 500 Buyback Index
The S&P 500 Buyback Index ranks the S&P 500 members in descending order of their buyback ratios every quarter and includes the top 100 in the Buyback Index. The index gives investors an avenue to invest in companies that are aggressively buying back their own shares.
The buyback ratio is calculated as the amount paid for common share buybacks divided by the total market capitalization of common shares at the beginning of the observation period.
A share buyback is a compelling route for a company to generate value for its shareholders, since a buyback contracts the number of outstanding shares, improving per-share measures of profitability and cash flow like earnings per share (EPS) and cash flow per share (CFPS).
Index Construction Methodology
According to S&P, the index is constructed as follows: "To account for the release of company reports, there is a three-month lag from the reference date for the observation period for the calculation of the buyback ratio. This observation period for the calculation of the buyback ratio is defined as the 12-month (or four-quarter) period ending one quarter before the reference date. As such, the observation period lasts 12 months (or four quarters) and begins 15 months prior to the reference date. The buyback ratios of the S&P 500 constituents are calculated as the monetary amount of cash paid for common shares buyback during the observation period divided by the total market capitalization of common shares at the beginning of the observation period. If the stock is not listed at the beginning of the observation period, the total market capitalization from the first listing day will be used for this calculation. Constituents then are ranked in descending order based on the buyback ratio. The top 100 securities form the index."
Share Buyback Trends
Buybacks in the financial markets have continuously been increasing, peaking in 2018 at $770 billion, with a slight drop to $709 billion in 2019. In addition, the capital amounts that companies are putting back into buybacks has experienced a compound annual growth rate (CAGR) of 10.4% since 2015. This compares to 7.1% for dividends, 5.5% for organic investment, and 1.45% for acquisitions made in cash. Markets were thrown in disarray during 2020 due to the Coronavirus pandemic, and it remains to be seen if buybacks will continue their upward trend once markets return to normal.
As of December 2020, the biggest sector contributors to the S&P 500 Buyback Index were financials (28.5%), information technology (19.8%), industrials (15.4%), consumer discretionary (14.6%), and healthcare (10.4%).
The positive reception by investors to share buybacks can be gauged by the outperformance of the S&P 500 Buyback Index relative to the S&P 500. The comparative chart is shown on the fact sheet prepared by Standard & Poor's, as are other attributes such as valuation fundamentals (price-to-earnings ratios) and risk metrics.
As they say, past performance is no guarantee of future performance, so with this index—and for any other index that has outperformed a chosen benchmark—an investor should be mindful of what drives performance and reassess the index before making investment decisions based on it.