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Timing the Market on Stock Buybacks

6/13/2014 --

Research by Michigan Ross Professor Amy Dittmar uses a new approach to answer an unresolved question in finance.

ANN ARBOR, Mich. — Companies repurchase their own stock for a variety of reasons, but when and at what price do they buy? Can they time the market?

That was an unsettled question until now. New research from Michigan Ross Professor Amy Dittmar shows evidence that some companies indeed time their repurchases and buy at a low price. Itís a way companies can make a shareholder-friendly move and a positive return on an investment.

"Stock repurchases get a bad rap sometimes," says Dittmar, associate professor of finance and Michael R. and Mary Kay Hallman Fellow. "Some people argue that itís spending money that should be invested in workers and facilities. But if managers can make a positive return over and above the risk they assume, it can be good for the firm."

Dittmar and co-author Laura Field of Penn State University analyzed monthly repurchase data from companies who bought shares on the open market from 2004 to 2011. Previous studies looked at long-run returns after a repurchase announcement, making it hard to determine exact purchase prices. Dittmar and Field collected data on the average price paid in a repurchase.

Using new data and methods, Dittmar and Field found the average firm buying its stock back on the open market pays 2 percent less than the average investor.

They also discovered companies that repurchase shares infrequently time the market even better, paying 6 to 8 percent less than the average price. Thatís because itís more difficult for firms that buy back shares frequently to time the market. A companyís shares arenít going to be undervalued that often, and these frequent repurchasers likely have other reasons to repurchase.

The higher returns get even better when insiders like executives buy stock on their own account in the same month, an indication those repurchases are driven by market timing.

"I believe in market efficiency, so I was kind of skeptical of the idea that firms could time the market," says Dittmar. "But the data gave us a peek inside a black box weíve never seen before and shed some light on a big question in finance."

The numbers also show that companies are able to time repurchases both to wider market prices, as well as their own stock price. Companies buy back stock for a number of reasons Ė to use available cash, to give shareholders a benefit in lieu of a dividend, or, more selfishly, to improve ratios.

Whatever the reason, the new research suggests that companies can time the market, especially if the buybacks arenít a frequent event.

Their paper on the subject is titled, "Can Managers Time the Market? Evidence Using Repurchase Price Data."



For more information, contact:
Terry Kosdrosky, (734) 936-2502, terrykos@umich.edu