Stock Market Buy Signals
Companies that buy back their own stock reduce their outstanding share count that, in turn, helps to boost earnings per share. Some argue that buybacks are not a good predictor of the stock’s future performance (e.g., executive officers of a company may encourage a buyback because their bonus may be tied to earnings per share). It appears that the best kinds of repurchases are ones that managers opt for simply because they view shares as cheap.
Three studies from 1995 to 2000 were based on the premise that buybacks from companies with low valuations was a superior criteria for predicted a risk in a stock’s price. Each of these studies came to the same conclusion using the price-to-book ratio—if the company’s P/B ratio was modest, a stock buyback helped. The S&P 500 companies have a median P/B ratio of 2.4 (source: Thomson).
Another approach that appears to result in positive returns is to seek out companies whose managers use their own cash to buy shares back. A study covering the period 1991 to 2006 shows the relationship between share repurchases and stock performance; stocks purchased by companies beat other stocks by almost 900 basis points over four years. Stocks that were the subject of both repurchases and insider trading beat others by 29 percentage points over the same four years