The Simple Way To Invest In The Market's 'Buyback Kings'

Chad Tracy's picture

Friday, January 18, 2013 - 5:30am

by Chad Tracy

Many top companies issue an overlooked type of payment back to their shareholders... They work like traditional dividends, but with one major difference -- these "dividends" are completely tax-free.

These under-the-radar "dividends" are a favorite of Warren Buffett and many other billionaire investors.

There's a good chance you've received one of these "tax-free dividends" before and didn't even realize it. That's because companies don't issue these "dividends" in the normal way. 

They "issue" them by buying back shares of their own stock.

You see, when a company buys back its own stock, it's similar to paying you a tax-free dividend. A buyback makes every share you own worth a larger piece of the company pie, but you don't have to pay taxes on your new portion of ownership.

On top of that, studies have shown that the share price usually rises afterward.

A study by U.K.-based investment group Shore Capital Group found that stocks with the biggest buybacks returned nearly four times more than the benchmark FTSE 350 Index in the past decade. This index covers the 350 largest companies by market capitalization on the London Stock Exchange.

Today, I'd like to show you how to purchase a basket of the top buyback stocks on the market all at once.

Like its name suggests, the PowerShares Buyback Achievers ETF (NYSE: PKW) owns a basket of companies that excel in share buybacks.

To be eligible for this exchange-traded fund (ETF), a company must be incorporated in the United States, trade on a U.S. exchange and must have repurchased at least 5% or more of its outstanding shares for the trailing 12 months. The fund's portfolio is rebalanced on a quarterly basis.

Right now, the fund's top-five holdings are IBM (NYSE: IBM), Home Depot (NYSE: HD), The Walt Disney Co. (NYSE: DIS), Intel (Nasdaq: INTC) and ConocoPhillips (NYSE: COP). Together, these five holdings make up 22% of the fund's overall portfolio.

This strategy seems to be working. The fund has gained 14% in the past year and 58% in the past three years.

By focusing on large U.S. companies that continually buyback shares, the fund is conservatively positioned. ETFs like PKW are perfect if you're the type of investor who wants to keep things simple with a "buy-and-hold" strategy.

One last tip: For more active investors, looking up the top holdings in ETFs like PKW or the Vanguard Dividend Appreciation ETF (NYSE: VIG) can give you a nice list of stocks for further research.

Risks to Consider: PKW only yields about 1% and charges a 0.7% annual fee. So investors eager for more yield now might do better off by investing in the top five holdings directly.

Action to Take --> If you're looking for a pure "buyback" play that keeps things simple, then PKW should be right up your alley. For bargain hunters, wait for a pullback and purchase shares when they're selling at a discount to NAV.

Chad Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.