By WALLACE WITKOWSKI at Marketwatch
With the Federal Reserve’s quantitative-easing program out of the picture, share buybacks are now the preferred way to boost stock prices in the face of softening earnings. But like QE, it is unclear how long the buyback boom can last.
In the first quarter of 2015, companies in the S&P 500 index SPX, -0.13% returned more money to shareholders than they earned. The last time that happened was in the fourth quarter of 2008, when the entire S&P 500 reported a slight loss for the quarter but still spent $110 billion on dividends and buybacks.
“This is not a normal trend,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. “This is a large amount of money being returned with the majority of it in buybacks.”
In the first quarter, S&P 500 companies spent $237.69 billion on dividends and buybacks, while reporting operating earnings of $228.36 billion, according to data compiled by Silverblatt.
Companies paid out more than they made in the first quarter.
Part of the reason for that cash hoard has been QE and near-zero interest rates, which have made it more attractive to take on debt to help fund share repurchases.
While there is no direct relationship between the two, the price tags on QE and buybacks offer an interesting coincidence: S&P 500 companies have spent about $2.41 trillion on buybacks over the course of the current bull market, according to S&P data, compared with a $2.37 trillion rise in the Fed’s balance sheet since the start of QE.
Even with the Fed expected to start raising interest rates toward the end of the year, the trend of padding earnings per share with buybacks continues, according to Silverblatt.
“It’s the addiction now,” Silverblatt said. “We’re trading in one for another.”
Silverblatt said about 12% of companies in the S&P 500 are already on track to reduce shares by about 4% or more, compared with the second quarter a year ago. He expects that to grow to about a fifth of the S&P 500 when all the numbers are in. That provides a significant tailwind to earnings per share, or EPS.
The impact of buybacks and dividends hasn't been lost on stock prices. In fact, they have exerted significant influence in the current bull market.
According to recent data from S&P, total buybacks and dividends (assuming those dividends were reinvested) have accounted for 35% of the buildup in market cap for the S&P 500 since it bottomed out in 2009. Without dividends, buybacks alone have accounted for 21% of the market cap’s rise.
With QE withdrawal, buybacks needed more to keep prices high
Shareholder returns have done their part to contribute to the bull market.
While shareholders applaud buybacks for lowering share counts, critics of the practice warn that they come at the expense of reinvestment and innovation, both in the form of job creation and investing in the company’s future.
Short-term share-price fuel vs. long-term innovation
Noted buyback critic William Lazonick, professor of economics at the University of Massachusetts Lowell, said in an interview that substantial buybacks are a symptom of a lack of innovation in dominant companies, the same companies that are pouring billions into buyback programs.
Companies like Hewlett-Packard Co. HPQ, -0.33% International Business Machines Corp. IBM, +0.06% Microsoft Corp. MSFT, -0.46% and Cisco Systems Inc. CSCO, -0.83% have completed huge buyback programs, but as revenue growth becomes more difficult, no amount of buybacks will help a company.
“If you can’t continue generating revenue and profit, then it becomes a problem,” Lazonick said.
While it might seem alarming to witness the entire S&P 500 paying out more in shareholder returns than it takes in via operating profits, it is a hallmark of most of the largest spenders on shareholder returns from 2004 to 2013.
Lazonick said if a company is spending more than 50% of its profits on shareholder returns, it isn’t investing in its future, and especially noting its employees, basically shortchanging middle-class workers of jobs and putting the proceeds into the pockets of hedge-fund managers and corporate executives.
“A big problem is just the power of Wall Street to just go after this money and take it out of companies,” Lazonick said.
A return to dividends?
The buyback frenzy boils down to corporate executives not finding better options for growth while being afraid to commit to hiking dividends, said Savita Subramanian, a strategist at Bank of America
“This is marrying your shareholder, not just dating him/her.”
Savita Subramanian, equity and quantitative strategist at Bank of America
“Buybacks still make sense if valuations are depressed, but this is no longer the case for most companies in the S&P 500,” Subramanian said. She would prefer companies spending more on research and development, capital expenditures when there is a need, or if returning cash to shareholders is a priority, instituting or growing the dividend.
“This is marrying your shareholder, not just dating him/her,” Subramanian said.
While quarterly spending on dividends has risen about 80% since early 2009, spending on buybacks has jumped nearly fivefold over the same period, according to S&P Capital data. In comparison, capital-expenditure budgets have grown 44% for the S&P 500 over the same period.
What’s tethering executives to a reliance on share-count reduction has been the growth of stock-based compensation, so companies are under the gun to buy back shares to prevent dilution.
Subramanian recently showed in a note that stock buybacks aren’t boosting share prices they way they used to, while companies that have invested in capex or M&A have posted stronger performances of late.