Companies return cash to investors by two methods—share buybacks and dividends. We regularly discuss exchange-traded funds (ETFs) that pay dividends. But today, we focus on share buybacks and introduce an ETF.
Share Buybacks Are Controversial
Most seasoned investors like investing in companies that pay dividends, which are cash payments to shareholders. In the US, dividend payments typically occur quarterly. In the UK, on the other hand, most companies pay out ‘ordinary’ dividends twice a year and sometimes issue 'special' dividends.
Investors also tend to favor companies that buy their shares back with extra cash. Companies which follow this strategy, tend to cancel those shares, reducing the number of outstanding shares on the market. As a result, the stock price of the company tends to go up, as the business now has the same earnings, yet fewer number of shares outstanding.
Corporate America loves dividends and share repurchases as “[b]etween 2010 and 2019, US firms distributed $4 trillion in dividends and $6 trillion in buybacks.”
In fact, “[s]ince 1997, share repurchases have surpassed cash dividends and become the dominant form of corporate payout in the US”
The S&P 500® Buyback Index measures “the performance of the top 100 stocks with the highest buyback ratios in the S&P 500.” Over the past year, it is up about 9%.
Many market participants regard share repurchases as a controversial topic. Research by Lenore Palladino, senior economist and policy counsel at the Roosevelt Institute, highlights:
“[W]hen a company executes a stock buyback, they raise the price of that company’s shares for a period of time, but the funds spent on buybacks are then unavailable to be spent on the types of corporate activities that could make the company more productive over the long term: investments in future productivity and in the workforce... Stock buybacks are virtually unregulated, even though Congress has recognized their potential for market manipulation.”
The Federal Reserve also concurs with this view and cites:
“Corporations are returning resources to shareholders instead of using them to boost capital investment, economic growth and jobs.”
Share buybacks can at times leave companies without enough cash to ride out the difficult times, similar to what we have seen during the pandemic.
In the past decade, for instance, most airlines including American Airlines (NASDAQ:AAL), Delta Air Lines (NYSE:DAL), United Airlines (NASDAQ:UAL), Southwest Airlines (NYSE:LUV), as well as Boeing (NYSE:BA) spent billions in share repurchases. But when the pandemic hit, their stocks prices went into free fall, and they were among the first ones to ask for handouts from the US government.
With that information, here’s our ETF for today.
TrimTabs US Free Cash Flow Quality ETF
Current Price: $47.36
52-Week Range: $26.28 - $47.44
Year-to-date (YTD) change: %17.82
Dividend Yield: 0.41%
Expense Ratio: 0.59%
The TrimTabs US Free Cash Flow Quality ETF (NYSE:TTAC) is an actively-managed fund that focuses on companies that buy back shares and also generate high free cash flow (FCF).
Most investors realize the importance of free cash flow, referring to cash a business can spend however its chooses, hence the word “free.” Management can look for new opportunities, like innovation, acquiring other companies or issuing a dividend.
TTAC, which has 242 holdings, started trading in September 2016. It aims to deliver higher returns than the Russell 3000 Index, which tracks the 3000 largest publicly-traded US shares.
In terms of sectors, financials have the highest weighting (29.44%), followed by information technology (27.20%), industrials (12.81%), health care (12.52%), consumer discretionary (8.60%), communication services (4.25%) and others. The top 10 names in the roster make up close to 20% of net assets of $186 million.
JPMorgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS), Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) lead the roster list.
Over the past year, TTAC is up around 17% and hit an all-time high in early January 2021. In a few days, US companies will release their quarterly metrics. As a result, we expect volatility in many of the names in the fund. In the case of potential short-term profit-taking, the risk/return profile of the ETF would improve. We’d look to buy the dips, especially around $43.
Bottom Line
It is unlikely that US businesses will stop share repurchases in the near term. As a result, the debate surrounding the topic will be with us in the coming quarters, as well.
For a range of market participants, investing in firms that buy back their own stocks could be appealing. In addition to TTAC, another ETF that could be of interest is the Invesco BuyBack Achievers ETF (NASDAQ:PKW). We plan to cover that fund in the coming weeks.