Debt Funded Buybacks: An Old Dog and Old Trick

Net Buybacks and Change in Debt for U.S. Companies are Correlated

Heartland Advisors Value Investing Market Insight Russell Chart

Source: Furey Research Partners and Russell®, 12/31/1985 to 3/31/2016
LTM: Last 12 Months

Since the end of the financial crisis, management teams have aggressively bought back company stock. Buybacks have slowed from recent peak levels but activity remains robust. We think the practice can be shareholder friendly, but believe not all share repurchases are equal. While stock buybacks can be a key component of a balanced capital allocation strategy, it is important to know how purchases are being funded.

Over the past six-plus years, many CEOs have relied on the use of debt to buy back company stock. The move is appealing for executives, because it can boost results by reducing the number of shares that have a claim on earnings. However, it’s not necessarily appealing to value investors like us who want to see low debt levels.

In spring, we were encouraged by a growing weariness toward the practice as companies with the most debt lagged the broader benchmark and were among the worst performers. But as the prospect of near-term higher rates has fizzled, so too has caution from investors toward leverage. With the threat of higher rates seemingly off the table for now, management teams have gone back to this old trick. We think it is short-sighted and prefer seeing share buybacks that are funded by free cash flow. Our reasons are two-fold: 1) it can unnecessarily add financial risk to company balance sheets, and 2) it paints a distorted picture of a company’s financial results.

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Author

Heartland Advisors Value Investing Research Analyst Andrew Fleming

Andrew J. Fleming

Fleming, CFA, is Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 8 years of industry experience, 5 at Heartland.

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