Once-Mighty Buybacks Land With Thud as Profit Margins Shrinkby
Repurchases less effective in masking declining earnings
S&P 500 Buyback Index at 16-month low versus broader measure
The share-enriching influence of buybacks, a pillar of the 6 1/2-year equity bull market, is diminishing. But that doesn’t mean companies have stopped trying.
A Standard & Poor’s index of companies repurchasing the most shares is trading at the lowest level in 16 months relative to an equal-weight gauge of S&P 500 members, Bloomberg data show. Meanwhile, U.S. companies bought back about $150 billion in the third quarter, up 14 percent from the previous three-month period, according to data compiled by S&P Dow Jones Indices.
Corporations have served as one of the biggest sources of fresh cash throughout the rally, churning out more than $2 trillion through repurchases, the data show. The buying has helped mask declining profits for companies in the S&P 500 and pushed valuations in the index past levels at the end of eight of the past 10 bull markets.
That influence is waning as the strengthening dollar and slowing global growth have crimped profit margins and companies now faced higher borrowing costs following the Federal Reserve’s first interest-rate increase in almost a decade, according to Mark Luschini of Janney Capital Management LLC.
“It’s been clear that the hundreds of billions of dollars that have been spent by companies to repurchase shares have been a direct boost to profitability,” Luschini, chief investment strategist in Philadelphia at Janney, which oversees about $68 billion, said by phone. “But we’re going to see less free cash flow going forward. Buybacks are a market tailwind that will continue to recede over the course of 2016.”
The S&P 500 Buyback Index, which contains the 100 companies in the benchmark gauge doing the most repurchases, has lost 7.2 percent this year, compared to a 5 percent loss for the equal-weight version of the S&P 500. If those moves hold, it would mark the first year since 2012 that the buyback index failed to outperform its broader counterpart. The repurchase gauge slid 1.9 percent at 9:32 a.m. in New York.
The profit margin for S&P 500 companies sits at 8.3 percent, down from 9.3 percent at the beginning of 2015 and poised for the worst year since 2009, according to Bloomberg data. At the same time, the average corporate borrowing cost for U.S. companies has risen to 4.6 percent, the highest since January 2012.
“Companies aren’t as cash-rich as they once were,” said Luschini. “Organic earnings growth is going to be manufactured by increased revenues, as opposed to buyback enhancements.”
A recent selloff in high-yield debt markets has added to worries that a growing number of companies may face a cash crunch. An exchange-traded fund tracking junk-rated stocks in the U.S. is down 3.9 percent in December, spurring concern that a commodity selloff and the Fed’s tightening will jeopardize solvency.
Buybacks have been an “important return factor since 2009” but have “stopped working,” Chris Verrone, partner and head of technical analysis at Strategas Research Partners, wrote in a Dec. 16 note to clients. It’s a “reflection that the liquidity market is more restrictive today than in years past,” he said.