By Jacob Sonenshine

Investors give share buybacks too much credit. But when the market has been dropping, repurchase activity could be a sign that an individual stock is about to rebound.

Companies that generate free cash flow, have cash on their balance sheets, and limited debt have many options for how to put that money to work. They can make an acquisition, pay a dividend, engage in capital spending, or buy back shares, among others.

Investors tend to love buybacks. In theory, they reduce a company's shares outstanding, which boosts earnings per share, the most commonly used profit metric for stock investors because it tells them how much of the company's profits they are earning for each share they own.

The trade-off is that the management team has opted to not invest even further in the business. Maybe for the moment, the company has excess cash and has invested in the business adequately, but unforeseen competitive threats from other players in the industry could emerge, necessitating more investment with the company's cash -- and lower share repurchases. Companies may also buy their shares back when the stock is too expensive, leading to lost opportunity when a stock falls.

Historically, buybacks haven't provided a big boost for stocks. Companies that have reduced their share counts between 0.5% and 2.5% annually since 2009 have seen their stocks outperform their benchmark indexes on a risk-adjusted basis by just over 0.8 percentage points on average, according to Trivariate Research. But companies that have increased share counts by 0.5% to 2.5% annually in that period have seen their stocks outperform by close to one percentage point on a risk-adjusted basis.

But as with everything, there are nuances. Companies that buy back shares after a month of market declines, for instance, tend to outperform in the month ahead. After a month of negative returns for the S&P 500, companies that buy back the largest amount of stock as a percent of their market capitalization average a return of just over 0.7% over the following month, or an annualized gain of almost 9%, higher than any other group that Trivariate studied. That's good to know given the S&P 500 has dropped 6.5% over the past month of trading.

Of course, that doesn't mean companies are creating long-term value or even allocating their excess cash efficiently, but it's useful information for shorter-term traders or investors who recently bought shares.

Trivariate listed a number of companies that announced additional buybacks to their existing repurchase programs this year. The list includes TJX Companies, Applied Materials, Booking Holdings and Merck, and they could be candidates for outperformance.

The list also includes Chipotle Mexican Grill. On its fourth quarter earnings report out early this month, management announced that it had boosted its total repurchase authorization to $1 billion from $700 million during the final quarter of 2024.

That's a reasonable number for this year, as analysts expect the company to generate just under $1.7 billion of free cash flow, has no debt to worry about, and almost $750 million of cash sitting on its balance sheet.

The stock is down 6% in the past month, but its buybacks suggest April will be more kind.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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March 24, 2025 01:00 ET (05:00 GMT)

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