Stock buybacks are in the news of late, but for precisely the wrong reasons. Specifically, they fell 28 percent in the third quarter from the previous year, to $115.6 billion. That’s the second consecutive three-month period of declines, and a multiyear low last seen in 2013.
That’s not exactly pleasant news for investors who believe in the power of buybacks lifting the value of your stock. But it also would seem to be problematic for a small set of buyback-focused exchange-traded funds, including the TrimTabs Float Shrink ETF ( TTAC), which got its start just a few short months ago.
But don’t count out buybacks — or TTAC — just yet.
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Buyback bedlam. Stock buybacks are one of a few ways companies redistribute their cash back to shareholders, generating a couple of positive effects.
By simply reducing the number of shares available, repurchases drive up the price of a company’s stock. But they also have something of a window-dressing effect — fewer shares helps raise earnings per share without having to actually improve one’s earnings.
Investors argue over whether buybacks are the most effective use of a company’s cash — versus, say, dividends or mergers and acquisitions — though broadly speaking, they’re considered a net good.
“Some institutions like buybacks more because they support the stock; individuals have a higher tendency to like the dividends because they can reinvest it in (dividend investment retirement plans),” says Howard Silverblatt, senior industry analyst of index investment strategy for S&P Dow Jones Indices. “But when people see a buyback program, that stock goes up, because they know there’s going to be buying.”
So a sudden, sharp decline in buybacks would at first glance seem troubling. But Silverblatt believes this is merely the Standard & Poor 500 index’s companies adjusting back to normalcy after a big first-quarter spend:
“Buybacks have been very high for about three years,” he says. “For the past three years, 20 to 22 percent of companies were reducing share count by at least 4 percent. During the fourth quarter (of last year) and the first quarter (of 2016), that jumped to 28 percent. It has now moved back down to that 22 percent.”
And looking ahead, several analysts believe buybacks could experience another resurgence in 2017 in the wake of Donald Trump’s election. Per FactSet’s third-quarter BuyBack Quarterly: “Buybacks could also get a lift if Trump passes tax reform, a package that is expected to include a one-time tax on the untaxed foreign profits of U.S. multinational firms.” That likely would lead to the repatriation of billions of dollars — much of which could be funneled into special dividends and, yes, buyback programs.
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If at first you don’t succeed … The TrimTabs Float Shrink ETF is an actively managed fund that invests in roughly 100 stocks selected by companies that shrink their “float” of available stocks — which can be done via methods such as reverse splits, sure, but typically is achieved via buybacks. However, TTAC also selects companies based on their ability to generate free cash flow.
That’s because buybacks on their own aren’t necessarily “good” — and in fact, can be a cause of concern depending on how responsible the repurchasing company is. For instance, says freelance analyst Will Ashworth, company management isn’t great at valuing its own stock.
“The biggest reason to dislike share repurchases is that CFOs are terrible at buybacks often buying at a stock’s 52-week high rather than 52-week low,” he says. “Unless used properly as (Teledyne co-founder) Henry Singleton did in the ’70s and ’80s, they are a waste of shareholder capital.”
In many cases, businesses aren’t even selective about when they repurchase shares, instead electing to implement buyback programs, in which they buy back a certain dollar amount of shares every quarter or year. And that’s fine to an extent — even if they’re not buying back their stock at the best prices, they’re providing a constant source of price support. But these programs only make sense if the companies can afford them.
“If a company is straining themselves to support their stock, that’s a bad situation,” Silverblatt says. “You definitely want to make sure they’re not straining themselves. You want to see where they got the cash from.”
That’s why TTAC’s focus on free cash flow is so pivotal to making a buyback-centric fund work, Theodore says.
“How do you find high-quality companies? It’s increasingly difficult because corporate earnings are so discretionary,” he says. “The metric that stands up over time is free cash flow. If you focus on cash flow, it’s not the most pure number you can find, but it comes a lot closer, but because at the end of the day, what goes in the bank and what goes out of the bank is where the rubber meets the road.”
Thus, TTAC currently is teeming with airlines — which, while extremely cyclical, are capable of generating excellent FCF — with United Continental Holdings ( UAL), Alaska Air Group ( ALK) and Southwest Airlines Co. ( LUV) all among the top 10 holdings in the ETF’s equally weighted portfolio.
Other notable holdings include the likes of hot-running Nvidia Corp. ( NVDA), as well as Marriott International ( MAR).
TrimTabs’ second lease on life. The TrimTabs Float Shrink ETF, which came to life on Sept. 28, naturally has very little track record, though it has returned 8.9 percent to the S&P 500’s 5.2 percent in its short life. But the TTAC is actually TrimTabs’ second shot at a buyback-focused ETF. They previously launched a similar fund with the same name — but the ticker TTFS — with AdvisorShares back in October 2011. However, AdvisorShares replaced TrimTabs as the sub-adviser earlier this year, installing investment management firm Wilshire Associates instead.
That came as a big surprise to Ted Theodore, TTAC portfolio manager, and the rest of TrimTabs’ team, who had a popular product on their hands when the switch was made.
“We were a five-star fund, very high-profile in terms of the followers of the founder of TrimTabs, Charles Biderman,” he says.” “It did cause a lot of questions.”
But the upheaval didn’t shake TrimTabs’ confidence in its strategy and methodology, so a few months afterward, TrimTabs Asset Management launched the Float Shrink ETF — but it did make one pivotal step away from TTFS in the process.
“We probably weren’t (AdvisorShares’) best friend in the sense that we said the fee is too high,” Theodore says. “It was 99 bps, and TTAC is 59 bps.”
That’s an extremely low fee that puts TTAC among the 10 cheapest actively managed equity ETFs. Combined with TrimTabs’ history in the limited float-shrink space, as well as a potentially accommodative environment for corporate buybacks, that’s enough reason to give TTAC a chance with a small allocation, at the least.
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“As actively managed funds go, its 0.59 percent management expense ratio is reasonable,” Ashworth says. “If I were an experienced investor and believed in the three criteria used to rank stocks in the Russell 3000: decreasing shares outstanding through buybacks, increasing free cash flow, and decreasing debt, I would be very interested in this ETF as a non-core piece of my portfolio.”
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Is the TTAC ETF the Right Way to Buy Buybacks? originally appeared on usnews.com
