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Buyback Wave Isn’t About to Wane

14 April 2015 in Trading Ideas

It was quite a day last week for General Electric.

The multi-industry behemoth announced to investors on Friday that it planned to focus its future in a modern-day version of its industrial past, with plans to restructure its finance unit and sell off a ton of real estate holdings.

In addition, GE said it planned to repurchase $50 billion of its stock.1

Yet while that dollar amount is at the high end of even the blue-chip company spectrum, the practice of companies feasting on their own publicly traded shares is not.

According to a recent story in the Financial Times, shareholders in the biggest US companies stand to receive a record $1 trillion in cash this year, as concerns by corporate giants over the global economic outlook divert cash away from investment and drive a boom in both buybacks and dividends.2

Dividends have climbed on average 14% annually over the past four years. Goldman Sachs forecasts buybacks to reach $604 billion this year, the FT said.

A Reuters report similarly suggested that the buyback appetite is unlikely to be satisfied soon, even if the US Federal Reserve begins to boost benchmark interest rates and shares get pricier.3

That would extend a pattern established in the last round of Fed tightening, according to a Reuters analysis of historical data. Many market analysts expect that higher borrowing costs won’t derail the buyback boom that has been bolstering stocks, the article said.

Buybacks may lift earnings per share of companies in the S&P 500 by between 1.5 and 2 percentage points this year, according to estimates from Voya Investment Management. With earnings estimates now calling for 1.5% growth for all of 2015, buybacks could make the difference between positive and negative growth in S&P 500 earnings per share.

Companies have ramped up stock repurchases since the practice bottomed for this cycle in 2009, Reuters said. The theory behind buybacks is to reduce the number of stocks in circulation, thereby boosting prices and calculated earnings per share.

In 2014, while the S&P 500 rose to record highs, component companies spent $553 billion on share repurchases, according to S&P Dow Jones Indices data – a 16.3% increase from the previous year and four times as much as they did in 2009.

The spree has accelerated this year. Pending and completed buybacks at all US-based traded companies in the first quarter rose to $179.7 billion compared with $124.2 billion a year earlier, up almost 45%, Thomson Reuters data show.

“Corporate management wants to do this trade,” Paul Zemsky, chief investment officer of Multi-Asset Strategies and Solutions at Voya Investment Management, told Reuters. “It’s being rewarded by the market, and it’s cheap to do.”

The S&P 500 buyback index, which includes the top 100 stocks with the highest buyback ratios in the benchmark, has outperformed the S&P 500 for seven years in a row.

Meanwhile, the Buyback Leaders motif has gained 3.4% in the past month. During that same time, the S&P 500 has increased 2.2%.

Over the past 12 months, the motif has risen 30%; the S&P 500 is up 16.7%.

With low expectations for first quarter earnings just starting to come in now, buybacks can be an effective and inexpensive way for companies to bolster their numbers, Zemsky told Reuters.

As the Fed initiates its plan to begin raising short-term rates – possibly by this September- companies that borrow money to buy their own shares will likely have to pay more. Still, even several rounds of rate hikes may still leave borrowing to buy back shares a profitable strategy, the article noted.

S&P 500 companies would, in total, earn back almost 6% of their investment in repurchases in the following 12 months, as calculated by the earnings yield, Reuters said. On the other hand, companies in good credit standing can now borrow money for 2.9 percent on average.

Given those rates, companies may continue to consider it cost-efficient to issue debt for buybacks.

1Steve Schaefer, “GE’s $50 Billion Buyback Continues Corporate America’s Binge On Its Own Stock,” forbes.com, April 10, 2015, http://www.forbes.com/sites/steveschaefer/2015/04/10/ges-50-billion-buyback-continues-corporate-americas-binge-on-its-own-stock/, (accessed April 13, 2015).

2Eric Platt and Michael MacKenzie, Financial Times, “US companies on course to return $1T to shareholders in 2015,” cnbc.com, April 13, 2015, http://www.cnbc.com/id/102581233.

3Rodrigo Campos, Reuters, “Stock buyback zeal undimmed by prospects for fed rate hike,” businessinsider.com, April 10, 2015, http://www.businessinsider.com/r-stock-buyback-zeal-undimmed-by-prospects-for-fed-rate-hike-2015-4, (accessed April 13, 2015).