Buybacks Have Jumped $535 Billion Shark in Barclays ViewMichael P. Regan
If you’re a chief executive officer of a public company sitting on a pile of cash, there are only a handful of categories where you can spend it.
You could, theoretically, buy every employee a pair of $300 Beats Studio headphones and a $250 iPod Classic that holds 40,000 songs. But all you’d end up with is a bunch of disgruntled younger employees wondering why they can’t download Tinder on that thing. And maybe a glaring example of why columnists are rarely named CEOs.
Otherwise, your choices are: a) capital expenditures to beef up business; b) acquisitions; c) dividend payments; d) share repurchases. While “all of the above” is obviously a common answer, the trends show that buybacks have taken a growing chunk of the spending pie. The reason is simple: reducing the number of shares in the earnings-per-share ratio is an efficient way to boost EPS, and companies that buy back the most shares have shown better stock performance.
That outperformance is not guaranteed, however, and in fact it disappeared earlier this year. Consider the Bloomberg Buyback Index of U.S. companies with the top announced repurchases in the previous 18 months. It was created on Oct. 9, 2007, the peak of the previous bull market, and increased 64 percent from inception through Aug. 18, compared with a 25 percent gain in the S&P 500. Year-to-date, however, it’s tracking the S&P 500 pretty closely and as recently as May its return was half that of the S&P 500’s.
In the future, the outperformance of buybacks will be “less robust,” Jonathan Glionna, Barclays Plc’s head U.S. equity strategist, wrote in a deep-dive report on the subject yesterday. Buybacks have worked best in periods of rapid stock gains like last year’s 30 percent jump in the S&P 500 and more advances of that magnitude are not in the cards, he wrote.
Furthermore, companies with large repurchases and fast net-income growth perform much better than those with large repurchases and slow income growth: “buybacks do not solve for slow growth,” Glionna wrote.
About $535 billion has been spent on buybacks in the past four quarters, contributing about 2 percentage points of earnings growth to the S&P 500, according to Glionna. The report states that repurchases eat up more than 30 percent of cash flow, nearly twice the proportion in 2002, while capex has fallen to about 40 percent from more than 50 percent in the early 2000s, the report said.
As a result of not focusing more on investments in their business, Glionna contends that revenue growth has been weak and is the “missing ingredient” for maintaining the strength of the rally in stocks that has almost tripled the S&P 500 in the past five-and-a-half years. Sales rose 3.4 percent last year for S&P 500 companies, according to data compiled by Bloomberg.
It all boils down to Glionna maintaining his target for the S&P 500 to end the year at 1,975, 1.3 percent below yesterday’s close while 6.9 percent higher for the year.
And you’re on your own when it comes to those Dr. Dre headphones now sold by Apple Inc. Compton and Cupertino, now you know you’re in trouble.