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Buybacks Have Bounced All The Way Back

1 December 2015 in Trading Ideas

While there were many casualties of the 2008-9 financial crisis, some of the more benign behaviors from the “good old days” have returned as healthy as ever.

This year, for example, publicly traded companies are on track for their highest level of stock repurchases by dollar volume since 2007.1

In the year’s first nine months, US companies spent $516.7 billion buying their own shares even with third-quarter reports still not complete, according to Birinyi Associates data cited in a recent Wall Street Journal article. That’s the highest amount for the first three quarters since the record set in 2007, the year before the financial crisis.

Buybacks can have a significant impact on earnings, the Journal explained, pointing to reports this quarter by companies including Microsoft Corporation (NASDAQ:MSFT), Wells Fargo & Co (NYSE:WFC), Pfizer Inc. (NYSE:PFE) and Express Scripts Holding Company (NASDAQ:ESRX).

For instance, Microsoft turned a decline in total earnings into a per-share gain by repurchasing a little more than 3% of its shares in the past 12 months. Its total third-quarter earnings were down 1.3% from a year earlier, but per-share earnings rose 3.1%, according to FactSet data cited by the Journal.

For Wells Fargo, a 0.6% increase in total earnings became a 2.9% gain in earnings per share after buybacks. At Pfizer, a 2% overall earnings gain became a 5.3% per-share jump. Express Scripts, a large drug-benefits manager, turned a 2.8% overall gain into a 12.4% per-share increase.

“More than 20% of all companies in the S&P 500 reduced share count by at least 4%” over the 12 months through the third quarter, Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, told the Journal. It marked the seventh quarter in a row that at least 20% of S&P 500 companies reported buyback share reduction. A buyback of 4% or more can have a noticeable impact on earnings per share, Silverblatt said.

He calculates that about 12% of S&P 500 companies already have bought so many shares that, even if their total fourth-quarter earnings don’t rise and they buy no more shares, their fourth-quarter earnings per share will be up at least 4%, due simply to reduced share count.

Other investment alternatives tied to the boom in buybacks have performed well recently. The Buyback Leaders motif has gained 2.5% in the past month. In that same time frame, the S&P 500 has increased 0.3%.

Over the past 12 months, the motif has gained 16.9%; the S&P 500 is up 1.1%.

This year’s buyback surge probably won’t surpass 2007 in total buybacks, but the Journal reported that announcements of planned future buybacks are the highest for any year’s first 10 months — more even than in 2007.

“If companies execute their plans, we are looking at a record amount being deployed over the next couple of years,” Birinyi analyst Robert Leiphart told the Journal.

Some analysts have said for years that the buyback pace will slow, but that hasn’t exactly materialized. Earlier this month, Nike Inc (NYSE:NKE) announced plans for up to $12 billion in buybacks over the next four years, following an $8 billion program that ends next May.

With corporate cash levels near records and interest rates low, use of cash or debt to finance buybacks is becoming widespread, the Journal noted.

However, a recent research report published by Research Affiliates (RAFI) has cast doubt onto what extent shares are really being reduced.2

According to RAFI’s study, US companies issued stock equal to $1.2 trillion last year. All told the new issues in 2014 exceeded share buybacks.

The RAFI study also found that “the cash flow statement often fails to report the majority of a company’s stock issuance.” Much of that unreported issuance is used as compensation for employees, primarily management. “When management redeems stock options, new shares are issued to them, diluting other shareholders” the report further notes. “A buyback is then announced that roughly matches the size of the option redemption. This facilitates management’s resale of the new stock.”

The conclusion is that what looks like buybacks are actually thinly veiled management-compensation plans, or in RAFI’s words, “simply a mirage.”

Still, many investors have already experienced what certainly seems like a cause-and-effect with buybacks and a higher share price – in some cases due to the simple boosting of demand of a company’s stock. As the Journal pointed out, most of the heaviest buyers of their own shares have seen their stock prices rise this year, with Apple Inc. (NASDAQ:AAPL) up 8.1% and Microsoft up 16.7%.

Investors may need to see an end to this virtuous cycle before they consider abandoning companies ramping up stock repurchase plans.

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1 ES Browning, “Is the Surge in Stock Buybacks Good or Evil?” wsj.com, Nov. 22, 2015.
2 Barry Ritholtz, “Why Management Loves Share Buybacks,” Bloomberg.com, Nov. 11, 2015, http://www.bloombergview.com/articles/2015-11-11/why-corporate-management-loves-share-buybacks, (accessed Nov. 29, 2015).