Bank of America Corp (BAC), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM): The Worst Buyback In Recent History

Speaking specifically about banks, a company should never repurchase shares when the premium to book value exceeds the company’s return on equity.

Take JPMorgan Chase & Co. (NYSE:JPM) as an example. Over the last 12 months, its return on equity has averaged 12.2%. To create shareholder value through buybacks, in turn, it should only repurchase its stock when the shares trade below 1.122 times book value. Any repurchases made above that level will necessarily have the opposite effect.

You can see how this plays out more generally in the chart below, which assumes that the underlying company earns a 10% return on equity.

Suffice it to say, there’s an inverse relationship between the multiple at which shares are repurchased and the ultimate effect on shareholder return. If shares are bought back at 0.1 times book value, for instance, the compound annual growth rate will go from 10% — that is, equal to its return on equity — all the way up to 53%. Alternatively, if shares are bought back at two times book value, then the CAGR will go from 10% down to 8.63%.

The breakeven point, as you can likely make out, is 1.1 times book value. At that rate — and again, this is assuming a 10% return on equity — the impact of a share buyback is neutral.

The Foolish bottom line

At the end of the day, it’s hard to dislike the idea of share buybacks. Before getting too enthused about them, however, it’s good to compare them to this simple benchmark.

The article Buybacks: Creating vs. Destroying Shareholder Value originally appeared on Fool.com and is written by John Maxfield.

John Maxfield owns shares of Bank of America. The Motley Fool recommends Bank of America and Berkshire Hathaway. The Motley Fool owns shares of Bank of America, Berkshire Hathaway, Citigroup, and JPMorgan Chase. 

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.