Buy thy neighbour

Share buybacks have been a recurring topic in financial research. Do shareholders gain or lose? If they gain, is it just because they take on higher risk? While the answers may differ, these are far from unanswered questions. Here’s a less researched question: How does this impact other listed companies?

We’re talking about large sums here. Over the past five years, Apple alone has bought back shares for $420 billion. Alphabet comes second at $264 billion, with Microsoft third, at $123 billion. That’s a large supply of liquidity.

Counting all the companies in the S&P 500, share repurchases last year totalled $942.5 billion, as compared to $629.6 billion in dividends paid. The above three companies represented more than 18% of this total.

Imagine you’re an Apple shareholder. Apple now buys back all or part of your holdings in the company and you suddenly find yourself sitting on a pile of cash. What do you do with the money? At the very least, you don’t feel like ploughing that money straight back into Apple shares, do you?

I’ve seen claims that 95% of the proceeds is reinvested in other stocks, but relevant figures are surprisingly scarce. ChatGPT has no clue. However, recent research by Byungwook Kim, at the University of California, Irvine, confirms this effect by measuring inflows into mutual funds – which receive inflows of about 1% about one quarter after buybacks amounting to 1% of the total stock market value. This effect, notably, is not seen for bond funds or bank deposits.

How, then, does this impact the stock prices of the other companies in the market? You may recall that I’ve written about the inelastic stock market (here and here), where capital flows not primarily governed by pricing can and will lift stock prices. Buybacks may logically represent a related case. To the extent that buyback sellers want to stay invested in the stock market, they have little choice but to buy at the present stock market pricing.

If so, the immediate effect will be a rise in stock prices. And yes, Kim is extraordinarily clear here: “Aggregate share repurchases positively predict market returns in the next quarter. The economic magnitude is sizeable: a one-percentage-point increase in share repurchase flows leads to a 6–7 percentage point increase in market returns in the following quarter.”

Could it be that buybacks occur in bull markets when stock prices are set to rise anyway? Apparently not. Kim actually finds that companies repurchase more actively during market downturns. Furthermore, the effect is stronger among non-repurchasing firms. There you have it: If you just sold your Apple stocks, buying Apple is not top of your agenda.

Not surprisingly, the effect is stronger among companies similar to the buyback companies (size, growth etc.). Given that growth companies tend to buy back a lot more shares than value companies, this may help explain the puzzling disappearance of the value effect.

A final point: The effect does not seem to be reversed beyond the first quarter. For now, buybacks seem to have lifted stock prices permanently.

For now.