Let’s face it, there are good buyback programs and bad buyback programs. The bad ones generally fall into the category of “we just want to offset the generous stock options packages for our executives,” or “we have no other uses for our cash, even though our shares are very richly valued.” On the flip side, my favorite kind of buyback program has one simple factor: shares trade below tangible book value.

#-ad_banner-#Buying back shares when they trade at a discount to book value is a no brainer. That’s because the share count can be cut by an even greater percentage than shareholder’s equity, which means that the price-to-book value will actually move lower.

One of my favorite insurance stocks is putting this strategy into action. Municipal bond insurer Assured Guaranty Ltd (NYSE: AGO) is using its massive cash hoard to buy its own shares on the cheap and will likely keep doing so until shares have risen 35% from current levels.

I wrote about this company nearly a year ago when management had just moved its headquarters to the United Kingdom — solely to speed the way to a faster pace of buybacks.

As you can see, book value per share has been rising at a steady pace. Note that shares currently trade for less than $25. Yet here’s the unusual thing: AGO must use very conservative accounting, eliminating the value of any investments (and debts) that are held by the company’s operating subsidiaries. Yet the company has made it clear in its filings that Assured Guaranty has 100% control over these subsidiaries and were it not for restrictive GAAP rules, operating book value would be $36.65 a share.

And this is where things get even more interesting. The company goes one step further and incorporates the net present value of its insurance premiums, and by that math, adjusted book value rises to $52.59 a share.

It’s worth repeating that shares currently trade for half that value. Seizing on that disconnect, AGO has bought back 33.3 million shares since March 2013, at an average price of $22.93 a share. Shares outstanding have fallen to a recent 165 million from 192 million in the first quarter of 2013. That number is likely to fall to around 155 million by the end of next year, according to BTIG Research’s Mark Palmer, noting that there is still another $300 million remaining on the current buyback authorization. According to the company, the ongoing buybacks have already added $2.16 to operating shareholders’ equity per share and $4.66 to adjusted book value per share. Also, AGO earns roughly $2.50 a share each year, which further inflates book value.

A healthy bond market

At this point, it’s fair to wonder why shares are so cheap. Blame it on Moody’s (NYSE: MCO), the bond-rating agency. Moody’s was pilloried in 2008 for failing to foresee the deep stress endured by many municipalities and still refuses to give top ratings to any municipal bond insurers. It didn’t help that hedge fund manager Meredith Whitney predicted a massive collapse in the municipal bond market — a prediction that was spectacularly incorrect.

In fact, despite some recent concerns in Puerto Rico and Stockton, California over the past year, the municipal bond market is now thriving once again. In the third quarter of 2014, AGO issued insurance against $3.8 billion worth of bonds, the highest quarterly rate in more than two years.

“For Assured Guaranty, par insurance increased each quarter through the year, and our year-to-date par insurance is 50% higher than in the nine months of last year,” said CEO Dominic Frederico on the Q3 conference call.

Although most municipalities issue bonds without any insurance, they are costing taxpayers money as a result of higher yields to compensate for default risk. Municipal bond buyers gladly pay up for the insurance as well. “Investors have witnessed our insured bonds price stability firsthand as those bonds tend to hold their market value, while for example, uninsured bonds of the same issuer trade at steep discounts,” added Frederico.

As investors come to see that the municipal bond market is healthy, look for investors to finally bid up shares closer to adjusted book value. BTIG’s Mark Palmer sets a $39 target price, which equates to 75% of current adjusted book value. Why such a discount? Because this business model does carry economic risk. A fresh economic downturn would increase the chances of a municipal bond bankruptcy. Still, that price target reflects more than 50% upside.

Risks To Consider: Every year, another city or county hits the headlines with news of financial distress. And every time that happens, municipal bond prices, as well as this stock, take a hit.    

Action To Take –> Assured Guaranty appears committed to share buybacks as long as shares trade at such a deep discount to book value. However, if the company determines that municipal bond market dynamic have grown so robust that it’s wiser to use its balance sheet for bond issuance, then it may not renew the buyback activity when the current $300 million authorization is exhausted. In either scenario, shares are positioned for solid upside as the gap to book value starts to close.

Share repurchases are one of three metrics we use to calculate a company’s Total Yield. And the companies that implement these three tactics responsible are some of the best performing in the market. In fact, from 1982 through 2011, the top 25% of Total Yield stocks returned 15.04% per year — smashing the S&P 500’s performance. For more information about Total Yield investing, click here.