Apple a convert to the buyback craze

The formula for success as a US finance director is simple: increase borrowing, buy back shares, watch the price rise and bank the annual bonus.

Apple has joined this buyback craze with the enthusiasm of a convert. Late on Monday, it said it would add $50bn to its programme this year, buying back $140bn of its own shares, plus those needed for staff options.

Shareholders were initially enthused, and Apple shares hit a new high before falling back.

But the excitement is not specific to Apple. Stocks with higher buybacks as a proportion of market value have outperformed the rest of the market for years. The S&P 500 Buy-back index returned an annualised 12 per cent over the past decade, against 8 per cent for the wider index, and performed particularly well in the past two years.

Investors should beware, though. With hindsight, buybacks tend to be criticised for taking place right at the peak of the market, often followed by the issuance new stock to strengthen the balance sheet when times get tough.

In fact, the problem is not so much with buybacks in themselves, as with the tendency of companies to borrow more during booms, forgetting that they inexorably lead to busts. Investors should be careful who they blame, however: in the good times, shareholders usually cheer on leverage, and the activists who campaign for more of it (David Einhorn and Carl Icahn in Apple's case).

There are genuine problems with buybacks. They ensure returns come through the share price, rather than in the cold hard cash of a dividend, increasing the value of executive options. They boost earnings per share, a measure often used for executive bonuses, even if profits are stagnant. In turn, they encourage management to focus on the capital structure instead of the underlying business.

But critics should not worry about the price at which the buyback happens. The problem comes not from buying back shares when they are expensive; this is merely a side-effect of taking too much leverage at the wrong time.

As the chart shows, companies are gearing up now much as they were just before the 2008 crisis hit. This time, with interest rates so low, maybe borrowing for buybacks can run for longer before it ends. Shareholders must hope so.

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