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Buyback Size Effect?

Posted in Buybacks-Secondaries, Size Effect

Do companies reliably repurchase their stocks at bargain prices, thus providing signals for investors to tag along? In the January 2012 update of their paper entitled “Do Firms Buy Their Stock at Bargain Prices? Evidence from Actual Stock Repurchase Disclosures”, Azi Ben-Rephael, Jacob Oded and Avi Wohl use detailed repurchase data from SEC filings since the beginning of 2004 (effective date for amendments requiring detailed reporting) to examine the timeliness of open market repurchases. Unlike much prior research, they focus on repurchase executions and not announcements. Using information from 10-Q and 10-K filings about actual monthly stock repurchases by S&P 500 firms (as of January 2004) and contemporaneous share price data for 2004 through 2006 (14,669 monthly observations for 416 firms with at least one repurchase), they find that:

  • During months with repurchases, repurchases on average constitute 3.3% of dollar trading volume and 0.41% of market capitalization of the stocks involved.
  • Small S&P 500 firms repurchase less frequently than large ones, and they execute at a price significantly lower than the average market price. Specifically, the third of S&P 500 companies with the smallest market capitalizations pay an average of 0.42% below the average monthly market price for repurchased stock. Firms in the middle and largest thirds pay approximately the average market price.
  • A plausible explanation is that insider-public information asymmetry is greater for small firms than large firms. Small firms tend to exploit this asymmetry by repurchasing opportunistically based on valuation. Large firms tend to focus on systematically executing announced repurchase programs.
  • Repurchase activity by the smallest firms on average anticipates a significantly positive abnormal return (adjusted for market, size, value and momentum factors) during the next three months. This abnormal return peaks in the second month after repurchase, perhaps because of the quarterly public disclosure interval. For large firms, the abnormal return is insignificant.
  • An optimized portfolio, restricted to the smallest third of the S&P 500, that is long the stocks of firms executing repurchases two months ago and short the other stocks in the subsample, reformed monthly, generates an average monthly return of 0.72% and an average monthly four-factor (market, size, book-to-market, momentum) alpha of 0.92% (12% annually). The weight for each long holding in this portfolio derives from repurchase size as a fraction of market capitalization, while short holdings have equal weights.

In summary, evidence from examination of post-2004 SEC filings indicates that actual share repurchases are informative only for smaller firms and that such information may be partly exploitable.

A logical extension to study findings is to focus on repurchase activity by firms smaller than the S&P 500.

Cautions regarding findings include:

  • As noted by the authors, investors cannot exploit the full annual abnormal return of 12% because the monthly data used is publicly available to investors only via quarterly SEC filings. Part of the abnormal return may be available to investors who diligently track publication of actual repurchases.
  • Reported returns are gross, not net. Including reasonable trading frictions would reduce returns, and trading frictions tend to be higher for smaller firms.
  • Repurchase signals may cluster (due to broad market conditions), complicating capital deployment for exploitation. Some subperiods may have no opportunities, and other subperiods may have too many to chase.
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