What Do Stock Buybacks Mean?

Posted on 07/02/2011


Recent research by Jacob Oded, Azi Ben-Rephael, Avi Wohl of Tel-Aviv University considered the matter by looking at share-price performance following buy-backs, the findings of which were published in the paper Do Firms Buy Their Stock at Bargain Prices? Evidence from Actual Stock Repurchase Disclosures.”   They learned the following:

Smaller S&P 500 firms repurchase less frequently than larger firms, and at a price which is significantly lower than the average market price. Their repurchase activity is followed by a positive and significant abnormal return which lasts up to three months after the repurchase. These findings do not hold for large S&P 500 firms. Our interpretation is that small firms repurchase strategically, whereas the repurchase activity of large firms is more focused on the disbursement of free cash.

They found that small firms (market capitalisation of $0.5-7.6bn) saw average market outperformance of 62bps in the fifteen trading days following a positive shock to the size of the firm’s repurchase program, while large companies (market capitalisation greater than $18bn) did not experience any significant outperformance.  In summary, when small companies repurchase stock, it may be a signal that the directors believe the shares are undervalued, while for large companies it is more likely to be a disbursement of cash (with the board paying no attention to the repurchase price).