Corequity Results since Inception[1]

Corequity has been screening its equity universe since 2004. The monthly results shown below cover 13 years, from September 2004-2017 The Undervalued Screen has achieved an average annualized gain over the S&P 500 of 5.20% while the Overvalued underperformed by 2.76% for a spread of 7.95% pa.

13 yrs relative to univ

While this may not seem like much to some, it is enormous. This chart shows what the actual gains would have been on an investment of $100 over the period.  The Undervalued Screens produce a return that is over 5.5 times that of the Overvalued.

$ return 13 yrs

The graph below shows the relative performance of the Screens[2] compared to our universe of stocks[3].

(c) 2017 Robert L. Colby

[1] For background please refer to https://corequity.org/about-2-2/ . For explanation of methodology please refer to https://corequity.org/category/guide-to-the-corequity-analysis

[2] Undervalued Stocks are in the highest quartiles of Valuation Return and the ratio of Normalized Earnings (MPEPS) to Estimated Earnings (EPS). Ovevalued Screens’ criteria are the opposite.

[3] Our universe most closely tracks the equal weighted S&P 500

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Short Term Results (16 months)

The performance of the screens have been particularly consistent since June 2016 as the graph below shows. The Undervalued have outperformed our Universe by 31% while the Overvalued underperformed by 19% for a spread of over 50% in 16 months.

16 mos rel s&p.png

Analysis of Short Term Results: Undervalued

The following tables on sectors and stocks show which were the largest contributors to these results.  The tables show the sum of the Relative Strength (to the S&P 500).

ANALYS UV

Here we can see that the major contributors to the superior performance of the Undervalued Screen were Technology, Industrial and Consumer Cyclical.

The top and bottom Undervalued stocks which contributed the most (and least) are shown here: ANALYS UV

Analysis of Short Term Results: Overvalued

ANALYS OV

The Sectors which contributed the most to the underperformance of the Overvalued were Energy, Financial and Basic Materials.  The individual companies in the top and bottom 10 are as follows:

TOPBOT OV

These attribution tables do not answer the question of why these results have been so consistent in the last 16 months.

A simple explanation would be value vs growth but this doesn’t hold up as the underlying principal of Corequity analysis is to put a price on growth specific to each company.  This is further supported by the recent relative performance of the ETFs SPYG and SPYV, being the Spider ETFs for S&P 500 Growth and Value stocks.

SPYV vs SPYG

This bears no resemblance to the UV/OV screen graph for the same period especially  if the same scale is used.

SPYV vs SPYG 70-140

(C) 2017 Robert L. Colby

Performance of Undervalued outperform Overvalued by 28.4% since June last year

In the last 9 months the Undervalued Screen has outperformed the S&P 500 by 21.2% while the Overvalued underperformed by -7.2%.  The absolute numbers were +33.8% vs +5.4%.

9 mos

Stay tuned for the a look at what Sectors, Industries and equities contributed to the divergent returns.

The graphs below show the performance of the two screens since inception on September 30th 2004.   Relative to the Corequity universe, the respective annualized returns are +2.68% pa vs -3.77% for a spread of over 600 basis points per annum.

The average return on the Universe is +2.04% pa which is more in line with the Equal Weighted S&P 500.

uvov graphs

Here is a look at the returns over the last year as well as since inception.

table

(c) 2017 Robert L. Colby

Stock Buybacks Equal Simple Interest

This article originally appeared on Seeking Alpha

Summary

  • Share buybacks are a poor asset allocation decision.
  • Buybacks reward share sellers not shareholders.
  • Buybacks can’t compete with investment returns.

seeking alpha logoConclusion: From the shareholders’ perspective, most stock buybacks produce little benefit when compared to investing the same funds in the company. They produce a one-time gain in earnings per share (usually small) but contribute nothing to the growth of the net profit or market capitalization. If a company is truly unable to successfully invest the buyback funds in its business, it would be much better for the majority of shareholders to receive a special dividend.

For the twelve months ending September 2016, total share buybacks were close to $600 billion for the S&P 500 companies. This is an enormous amount of money being 66% of the earnings and only slightly less than fixed capital expenditures in the same period. The average buyback program resulted in a “buyback yield” just shy of 3%. This resulted in a very modest annual decline in the shares outstanding which led to an equally modest one-time gain in earnings per share for shareholders, i.e. the vast majority who did not sell their shares.

Because buybacks and dividend yield are considered to be returns to the shareholder, they tend to be lumped together in statements like “total shareholder yield is currently close to 5% comprised of a 2% dividend yield and a 3% buyback yield”.

“Buyback yield” is very misleading. As the source of funds for buybacks is operating cash, it should be first and foremost compared to what they would have achieved if invested.

A 3% “buyback yield” is greatly inferior to investing in the company’s business, acquisitions, or even a special dividend, which would be shared by all shareholders in hard dollars as opposed to soft dollar benefits attributable to fewer shares.

Here is an example of a typical S&P 500 equity. It has a market cap of $15 billion; its shares are at 15x earnings and it buys back 3% of its outstanding shares. This is compared to a hypothetical, but very conservative investment producing 3% in the 1st year, 8% in the 2nd and 10% thereafter. (This analysis is independent of the underlying profitability of the company.)

Undervalued Screens outperform Overvalued by 22% since June 30 last year

January adds another 4 % to the spread between the Undervalued (UV) and Overvalued (OV) screens performance since 6/30/16. This chart shows the relative performance to the average of our universe.

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Here are summary tables showing which Sectors contributed to the superior performance of the Undervalued and the poor performance of the Overvalued.

jun-jan-screens

The methodology is to add up the cumulative monthly Relative Strength[1] of the screened equities by company, industry and sector and rank the Sectors (in this case) by the total contribution to their performance over the period.

[1] The percent change in price relative to the S&P 500

For more detail email corequity@gmail.com

(c) 2017 Robert L. Colby

The Mechanics of Stock Buybacks

Conclusion: From the Shareholders perspective most Stock Buybacks produce little benefit when compared to investing the same funds in the company. They produce a onetime gain in Earnings per Share (usually small) but contribute nothing to the growth of the Net Profit or Market Capitalization. If a company is truly unable to successfully invest the Buyback funds in its business, it would be much better for the majority of shareholders to receive a Special Dividend.

For the twelve months ending September 2016, total share buybacks were close to $600 billion for the S&P 500 companies. This is an enormous amount of money being 66% of the earnings and only slightly less than Fixed Capital Expenditures in the same period. The average buyback program resulted in a “buyback yield” of just shy of 3% [1] . This resulted in a very modest annual decline in the shares outstanding which led to an equally modest one time gain in Earnings per Share for the Shareholders, i.e. the vast majority who did not sell their shares.

Because Buybacks and Dividend Yield are considered to be returns to the Shareholder they tend to be lumped together in statements like the “Total Shareholder Yield is currently close to 5% comprised of a 2% dividend yield and a 3% buyback yield”.

“Buyback yield” is very misleading. As the source of funds for Buybacks is operating cash, it should be first and foremost compared to what they would have achieved if invested.
A 3% “buyback yield” is greatly inferior to investing in the company’s business, acquisitions, or even a Special Dividend which would be shared by all Shareholders in hard dollars as opposed the soft dollar benefit attributable to fewer shares.
Here is an example of a typical S&P 500 equity. It has a market cap of $15 billion; its shares are at 15x earnings and it buys back 3% of its outstanding shares. This is compared to a hypothetical but very conservative Investment producing 3% in the 1st year, 8% in the 2nd and 10% thereafter. (This analysis is independent of the underlying profitability of the company.)

feb7-chart1

The share purchase of 3% of the float produces a 3.5% pop in the EPS on day one.  Annualized that is 3.5% in the first year, 1.7% per annum in the second and so on declining each year.  By the second year, the Investment produces a higher return.  By year 8, the Investment led to a Net Profit of $985m which is almost double the first year’s investment while the Buyback produced zero contribution to Net Profit.

Were the stock price reduced by half and the Buyback amount kept the same you would get the following result.

feb7-chart2

The original gain in EPS is increased to 7% but it soon pales by comparison to the Investment.

Using the original price of $15 and twice the buyback funds ($1,000m), the result would be the same as in the previous example but the dollar gain in the Net Profit from Investing would double as twice the funds were used.

feb7-chart3

These hypothetical examples illustrate the mechanics of stock buybacks.  Now let us look at two actual examples.

The first is Apple as it is listed as the most aggressive in terms of dollar amount of funds spent on buybacks in the last 12 months.[2]

feb7-chart4

Despite Apple having spent the over $30 billion, it confirms the disadvantages of Buybacks compared to Investments.  In this case we used the average Return on Capital that they earned from 2009-15.

Now let us look at one of the most aggressive buyback programs in terms of the percentage of stock that was bought.  Corning Inc. purchased over 20% of their outstanding shares in the last 12 months [3] which produces an initial gain of 27% in EPS on day one.

feb7-chart5

However, even this aggressive program fails by beat the Investment after year three even though Corning’s Return on Capital is only averages at 10.3% over the 7 years. This illustrates that even massive amounts of buybacks can’t change the fundamental disadvantage compared to investing.

One of the reasons that investors are not more critical of management for stock buyback programs may be because, by doing it year after year, it creates the illusion that it is compounding.  As shown here, each year’s transactions is still the equivalent of getting simple interest.

The proof of this is found in the Net Profit Test[4]. It answers the question:

What is the Required Rate of return on an Investment of the funds, that would grow the Net Profit at the same rate that the EPS grew due to fewer shares.  Like Apple, the answer is surprisingly low in most instances.  We analyzed 30 stocks[5] whose buyback programs resulted in a median decline of 25% of their outstanding shares from 2008 to 2015. The median Required Return would have been only 4.9%.

The median growth rate for their EPS was 7.7% pa while the Net Profit grew only at 2.4%.  Instead, by investing at less than 5%, the Net Profit would have been 42% higher in the 7th year. Over the seven years the cumulative gain in Net Profit would have been 1.8x the original investment.

It makes no sense to put the growth of Earnings per Share ahead of the growth of Net Profit and as a result, the growth of the Market Capitalization.

A Simple Test to Dispel the Illusion Behind Stock Buybacks

Fair Game

By GRETCHEN MORGENSON AUG. 12, 2016

“Mr. Colby has developed an illuminating analysis that identifies a crucial difference between many truly successful companies and their underperforming counterparts. The exercise highlights the growth mirage that buybacks have on earnings-per-share measures. In addition, it shows that returns on investment need not be that large for a company to generate growth rates exceeding the evanescent earnings-per-share gains associated with buybacks.”

Footnotes

1.Factset Buyback Quarterly December 19, 2016. Defined as the buyback funds divided by the market capitalization.
2.Factset
3.Factset
4.The Net Profit Test: Comparing Buybacks to Investment
5.Stocks with significant buybacks between 2008-2015

© 2017 Robert L. Colby