Back in August, I told readers how Corporate America has been repurchasing their own stocks at a record rate.
According to Standard & Poor's, the 500 largest U.S. companies (that make up the S&P 500 Index) spent nearly $159.3 billion to buy back shares of their own stock in the first quarter of this year (the latest data available). That is the highest quarterly amount spent in seven years and twice what corporations spent on dividends.
That said, investors should know there's a wrong way and a right way for corporations to promote share price gains through stock buybacks -- one that can lead you to significant investment losses, and the other that could lead to you market-beating gains.
First, the wrong way. Because share buybacks boost a company's earnings per share (EPS), many large companies that have seen sluggish revenue growth over the past few years have been abusing this practice.
And back in July, I told readers of a well-known company doing just that:
"Take International Business Machines (NYSE: IBM) for example. The legendary company has been the poster boy of share buybacks for years now. Since 2010, IBM has purchased 200 million of its own shares, shrinking its share count a whopping 16% from 1.29 billion shares to 1.08 billion shares today.
But at the same time, the company's annual sales have stayed flat over the past four years. In fact, the company's sales over the past 12-months are actually lower than they were in 2010 -- $98.8 billion now compared to $99.8 billion in 2010.
The per share value added from these buybacks have no doubt made some shareholders happy, at least for now. But it remains to be seen if investors will be happy to continue owning large companies like these that aren't actually growing their top lines -- buybacks or not."
Nearly four months later, it looks like investors may finally be calling IBM's bluff in their aggressive "window dressing" of profits per share.
Shortly after reporting another quarter of declining revenues, investors sold off their shares in droves. Shares of IBM fell 8% on October 20 alone, and due to the sheer size of the company, the selloff was enough to drag down the Dow Jones Industrial Average by a whopping 85 points.
Over the past three months, IBM shares are down roughly 13%.
It remains to be seen if shareholders will punish IBM further from here for its sluggish top line growth. And make no mistake, there are many other large buyback imposters just like IBM waiting for a similar share price correction.
But what's clear is this: To avoid land mines and have a better chance at finding market-beating stocks, investors are best off finding companies that not only buy back shares of stock, but also have a track record of revenue growth.
Our growth and income expert Nathan Slaughter uses this strategy to find some of his best-performing stocks. As he told readers in his October issue of Total Yield:
"I like to get the best of both worlds -- a growing business AND fewer shareholders [from buybacks]. When you have steadily growing net income and a shrinking share count, that's when great things can happen.
With that in mind, I went out in search of exceptional companies returning at least 6% annually through dividends and buybacks. Next, to make sure the business is growing naturally rather than artificially, I screened for companies with more customers coming in the door. Specifically, those companies showing healthy revenue growth of at least 15% annually over the past three years -- with further top-line expansion projected next year.
Earnings growth at these firms isn't being driven by share repurchases -- only enhanced."
You can see how these companies fared over the past three years thanks to strong revenue growth combined with aggressive share buybacks:
Nathan adds that one of the most common misperceptions about companies returning buckets of cash to investors is that they have exhausted their organic growth opportunities.
But that's simply not always the case. In fact, these companies are all expected to post strong 2015 revenue growth (see table below) and continue rewarding shareholders with aggressive buybacks and dividends raises in the years ahead.
All of which could give these buyback machines a strong chance for healthy gains into the future, especially if their three-year-plus track record of market-beating gains have been any guide.
P.S. -- If this list of outperforming buyback companies has you excited, you'll want to check out Nathan Slaughter's latest Total Yield research. There you'll see how the market's most aggressive share-repurchasing stocks returned more than 119% from 2008 to 2014, nearly doubling the S&P 500's 66% return over the same period. You'll also get access to several names and ticker symbols of the most aggressive buyback companies that Nathan believes are worth owning today. I invite you to watch Nathan's free presentation to get all the details.
This article was originally published on StreetAuthority.com: 5 Buyback Leaders That Keep Beating The Market