Higher returns and reduced risk offer the ultimate free lunch in investing; one of my favorite, and most profitable investment strategies focuses on companies that buy back their own shares, explains Nicholas Vardy in Eagle Daily Investor.
When a company announces that it will buy back its own shares, it means a couple of things. First, the company is healthy enough to have sufficient cash on its balance sheet to execute the buyback. Second, the company is focused on maximizing returns to its shareholders.
By reducing the number of shares outstanding, management increases a company's earnings per share, without the really hard work of having wrung out operational efficiencies.
Share buybacks are also generally a more tax-efficient way to return capital to shareholders, compared with paying out taxable dividend payments.
Rather than investing in individual stocks where management has announced a share buyback, my Number One choice to invest in buybacks is through an ETF.
Over the past six years, ending in 2013, PowerShares Buyback Achievers ETF (PKW) outperformed the S&P 500 (SPX) five out of six times, often by significant margins.
The ETF tracks the Buyback Achievers Index, which consists of companies that have reduced their outstanding shares by 5% or more in the past 12 months.
PKW uses a modified market-capitalization methodology, where the largest weighting for any company is 5% of the ETF's assets.
It re-balances these holdings quarterly in January, April, July, and October, and the fund currently has about 40 holdings.
Many of the companies PKW invests in are household, blue-chips. Pfizer (PFE), Oracle (ORCL), Home Depot (HD), AT&T (T) and General Motors (GM) are the five largest holdings in the fund, with 3.5% to 5% weightings each. And with a beta of 0.96, PKW is actually slightly less volatile than the S&P 500.
Meanwhile, I was excited to learn that PowerShares is going global with its "buyback achievers" strategy through a new ETF, PowerShares International BuyBack (IPKW).
Like its domestic parent, the underlying portfolio consists of international companies that have reduced their outstanding shares by 5% or more in the past 12 months. Although this brand new ETF, itself, has no record to speak of, the back testing of this approach is encouraging.
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