Winning Funds Bet on Companies Repurchasing Shares

NEW YORK ( TheStreet) -- Seeking income, investors have poured into dividend exchange-traded funds. Lately the move has proved rewarding.

During the past three years, PowerShares Dividend Achievers ( PFM) has returned 12.5% annually, outdoing the S&P 500 by a percentage point, according to Morningstar.

But instead of focusing on shares with rich dividends, investors could have done even better by holding companies that have been buying back their stocks. During the past three years, PowerShares Buyback Achievers ( PKW) returned 15.1% annually.

The outlook for the buyback fund remains bright. While sales of S&P 500 companies are growing at an annual rate of 1.8%, the stocks in the buyback fund are growing 9.2%. Despite their superior characteristics, the buyback stocks sell at a discount, commanding a price-earnings ratio of 13.4, compared to a multiple of 14.2 for the S&P 500.

To be included in the buyback fund, a company must have reduced its number of shares by 5% in the previous calendar year. The fund currently holds 245 stocks from a universe of 4,000 names. Big holdings include such blue-chips as International Business Machines ( IBM), Intel ( INTC) and Home Depot ( HD).

Buybacks tend to prop up stocks, says Timothy Alward, CEO of Ford Equity Research, which devised the benchmark that is used by PowerShares Buyback fund. As shares are reduced, the earnings attributed to each remaining share increases. As a result, companies that repurchased shares have outperformed the markets over long periods.

Buyback stocks can be defensive holdings, says Alward. Only steady businesses with strong cash flows can afford to repurchase big chunks of their shares. "The buyback index tends to do a little better in downturns than the market as a whole," he says. "During strong rallies, the index stays close with the market."

When the market collapsed in 2008, PowerShares Buyback Achievers lost 33.6%, outdoing the S&P 500 by 3.4 percentage points. So far this year, the fund is up 13.6%, compared to a gain of 16.4% for the S&P 500.

Despite the recent rally, many buy-back stocks sell at big discounts to their fair values, argues Bill Nygren, portfolio manager of Oakmark Select ( OAKLX), a mutual fund. Nygren's views are worth considering. During the past 15 years, his Oakmark fund returned 9.1% annually, outdoing the S&P 500 by four percentage points and ranking as the top-performing large blend fund.

If you liked this article you might like

Getting an Edge With 'Fundamental Indices'

Getting an Edge With 'Fundamental Indices'