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What investors should like about stock buybacks

The Hasbro logo is seen on the box of a Monopoly game in New York.


Predictably, investors are getting a deluge of warnings about the coming of a sharp market pullback. What to do? One thing is sure, volatility will again dominate the scene, but that isn't necessarily bad for investors. Volatility presents buying opportunities for both the bulls and the bears.

The bears love to short stocks when prices swing way up, as they are doing now, while the ardent and seasoned bulls jump at opportunities to buy their favoured stocks when the pendulum's downswing pulls prices way down.

But this time around, some intrepid pros are pursuing a relatively new strategy: Adopt the share-buyback theme. In other words, buy into companies that are more seriously and extensively repurchasing their own shares.

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"In these times of market volatility, the recipe for investment success may be as simple as taking the S&P 500 and adding the characteristics provided by buybacks as the market heats up in the second half," says Jeffrey Kleintop, chief market strategist at LPL Financial.

Even as the market has kept on climbing to new highs this year, "we are still positive on the market," he asserts. LPL Financial is one of the major market players, with it's total brokerage and advisory assets rising to $397-billion so far this year, from $341-billion two years ago.

Part of his optimism is based on his perception that the individual investors haven't fully embraced the bull market, and have yet to jump in. "They are still more comfortable in seeking protection in bonds," partly because of concern over the volatility in the equity market and the economy's slow growth.

But individual investors will be a huge additional factor when they finally decide to buy in, says Kleintop. Eventually, the rising stock prices as well as the buyback-theme strategy will help attract the reluctant individual investors back to the market.

Kleintop argues that investors "seeking an enduring recipe for success in the changing environment of the second half of the year may find it in share buybacks." So far this year, the buyback strategy has worked well, he notes, with the S&P 500 Buyback Index posting a total return of 25.4 per cent compared to 15.7 per cent for the S&P 500-stock index.

The S&P 500 Buyback Index provides exposure to the 100 constituent companies in the S&P 500 with highest buyback ratio in the past 12 months. The buyback ratio is defined as the amount of cash paid for common shares bought back in the past four calendar quarters, divided by the total market capitalization of the common shares at the beginning of the buyback period.

Kleintop expects the Buyback Index will continue to outperform the market in the second half.

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Among the companies that will do buybacks for the first since the financial crisis is Morgan Stanley, one of the largest U.S. financial services companies with operations in investment banking, securities, and investment and wealth management. The company, which has announced it will repurchase stocks worth $500-million, is expected to see a 25 per cent revenue growth n 2013 and 7 per cent advance in 2014 based on a rebound in sales, trading, and investment banking.

A big driver ahead for Morgan Stanley is its increasing focus and investment in its Global Wealth Management Group business, which accounted for 52 per cent of total revenues last year, up from 31 per cent in 2007, says Kenneth Leon, banking analyst at S&P Capital IQ. He rates the stock as a buy. Currently trading at $27 a share, he sees the stock rising to $32 in 12 months.

Hasbro, a worldwide leader in children's toys and family leisure and entertainment products, is another buyback play. It has authorized an additional $500-million to its stock-repurchase plan. It has $71.8-million left from its 2011 repurchase-program after repurchasing $2.8-billion worth of shares at an average price of $30.30 a share. The stock is currently trading at $46, up from a 52-week low of $34.

Hasbro's broad portfolio of toys and games include such brands as Transformers, Playskool, Monopoly and My Little Pony. The company is well-positioned to benefit in 2014 from cost reductions as an improved pipeline of entertainment products help drive increased sales growth, says Joseph Agnese, analyst at S&P Capital IQ.

Another attractive stock pursuing a buyback strategy is American International Group, a leading international insurance company, which was rescued by various government agencies in 2008 and has fully repaid its $182.3-billion in government aid.

AIG has authorized a buyback program of $1-billion. S&P analyst Cathy Siefert views AIG as undervalued versus its peers and historical averages, particularly on a price-to-book basis. Now trading at $48 a share, Siefert rates the stock as a buy with a 12-month price target of $54.The company has been streamlining its operations as it seeks to narrow its focus to property-casualty, life and retirement savings activities, notes the analyst.

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In pursuing his share-buyback strategy, LPL's Kleintop doesn't ignore the risks involved. Apart from the ever-present dangers of stock market investing, the risks unique to a buyback-focused portfolio include the likely change in Federal Reserve policy as the aggressive stimulus of the past five years begins to fade.

He also warns that in a fear-driven market selloff, it's possible that the buyback portfolio might underperform the S&P 500 should investors favour the largest, most well-known companies because the portfolio is underweight mega-sized companies relative to the S&P 500 index.

The sectors that Kleintop believes will outperform the market in the current environment are the consumer discretionary and health care segments of the economy. "These domestically focused and consumer-driven sectors of the stock market may fare better due to a relatively brighter U.S. economic growth and employment outlook and a rising dollar," he notes.

Financials will also benefit, says Kleintop, as the rise in longer-term interest rates widens profit margins on lending as business loan demand improves.

What to avoid: Materials and energy stocks which, Kleintop points out, are commodity-based sectors that may not do well as they suffer from over-capacity and weak global demand. Add to the "Avoid-List" the utilities and telecom services companies, says Kleintop. "They are bond-like, yield-sensitive sectors would likely underperform as bond yields rise and prices fall," warns the strategist.

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