The Profits In Stock Buybacks

Keep your eye on companies announcing plans to repurchase their own shares on the open market. A National Bureau of Economic Research study by David Ikenberry, Josef Lakonishok, and Theo Vermaelen, finds profitable opportunities in such news.

In an analysis of stock movements on the major U.S. exchanges from 1980 through 1990, the economists found that prices of stocks named in repurchase announcements rose by an average of about 3.5% relative to the market in the days immediately following the news releases--a modest increase. If held over the next four years, however, a significant number yielded returns averaging some 45% more than the market.

The high performers were so-called value stocks, the fifth of the repurchase group with the lowest prices relative to book value. On the other hand, glamour stocks, which enjoy high price-to-book-value ratios, failed to outperform the market over a four-year period.

In short, when companies with low prices relative to book value explain their repurchase plans by claiming that their shares are "undervalued," they are often telling the truth.

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