Buyback news is an unreliable ‘buy signal’

Reading time: 2 – 2 minutes

Many investors have finally caught on that stock buybacks are a manipulative device used by company management to increase market levels and give value to stock options.

Now, there are newsletters that inform short-term traders when companies announce equity repurchase programs.

The idea is to buy on the announcement and sell as prices rise.

Changing times

Buying on buyback news might have been a good idea ten years ago; it is certainly no longer a sure-fire, get-rich-quick formula.

A false 'green light'

Now buybacks are in high fashion; everyone is doing it and it is becoming difficult to find companies that are not jumping on the band wagon.

In 2005, net buybacks totaled $366 billion, and net sales by individual investors (mostly option holders) reached $501.1 billion.

The result: instead of stock prices soaring in 2005, sales by insiders exercising options kept the rise to less than 3% for the year.

In fact, net stock sales by individual investors have been outpacing stock buybacks for a decade.

Covariance is a problem

The only thing keeping the stock market from crashing seems to be naive, long-term investors who continue to buy and hold equity funds through automatic tax-deferred savings plans.

The flaw in the buy-on-buyback-notice scheme is market covariance.

The buyback program of a single company will not be able to drive prices upwards in the face of a general market downtrend.

At this point, the short-term trader, reading charts and betting on buyback tips, may find that better results would have been obtained by paying attention to Capital Flow Analysis and the Federal Reserve flow of funds tables.