Companies can’t get enough of their own stock.
Ninety-eight share buybacks were announced through the first two months of 2018, according to JPMorgan Chief U.S. Equity Strategist Dubravko Lakos-Bujas as reported in Barron’s. The 98 amounts to $151 billion worth of purchased stock.
Lakos-Bujas goes on to predict that companies could buy back as much as $842 billion worth of stock on an annualized rate this year. If so, it would be a record. It would exceed the $530 billion worth of stock purchased in 2017.
The immediate benefit is obvious: By reducing the share count, companies increase the earnings allocated to the shares remaining.
The $530 billion of buybacks last year added two percentage points to EPS growth. With over $800 billion worth of buybacks expected this year, the bump-up to EPS could reach 3%, according to Lakos-Bujas.
I suspect the benefits of share buybacks are less tangible than JPMorgan reports. I even suspect the costs of share buybacks outrun the benefits, particularly this late in the bull market.
Many companies are buying back shares with cash from other sources than operating cash flow. Many have issued more debt to buy back shares. They’ve issued debt in significant chunks.
Apple (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT) have seen long-term outstanding debt triple since 2014. Intel (NASDAQ: INTC) and Oracle (NASDAQ: ORCL) have seen their long-term debt outstanding double.
The impetus to buy one’s own shares extends beyond tech. McDonald’s (NYSE: MCD), PepsiCo (NYSE: PEP), and American Airlines (NASDAQ: AAL) have all loaded up on debt while they draw down their share count.
To be sure, all the new debt isn’t earmarked for share buybacks. The debt is also used to finance investment to grow the company. In most instances, the debt is issued on favorable terms at rates unseen since the first half of the previous century.
But it’s still debt, and debt elevates financial risk.
When it all goes swimmingly, as it has for eight years, debt is easily serviced. It amplifies return. When it all goes less swimmingly, debt becomes a millstone, and one difficult to shed. Too little debt is never the cause of bankruptcy.
The one investor every investor follows is the one investor eschewing the buyback binge.
Berkshire Hathaway (NYSE: BRK.b) holds $106 billion of cash and cash equivalents. Not a dollar has been spent on share buybacks. Warren Buffett has set a share price of within 120% of book value. Both the Class A and B shares trade near 170% of book value. Berkshire is unlikely to buy back shares unless a genuine market correction occurs.
Buffett’s reluctance to buy tells us something. Price matters. It appears to matter more to Buffett than it does to most in the executive suite.
If Buffett is reluctant to buy Berkshire’s shares should other companies be reluctant to buy their shares? Is the best use of company funds to buy shares after the shares have increased sixfold in the past 10 years, a la Apple?
I suspect it isn’t. The evidence supports my contention.
The reality is that major U.S. companies tend to do buybacks in bull markets and cut back, often sharply, in bear markets. They buy high. If they sell, they sell low. Research by the Academic-Industry Research Network, a nonprofit, shows that companies that do buybacks never resell the shares at higher prices.
General Electric (NYSE: GE), for example, spent $3.2 billion on buybacks in the first three quarters of 2008. It paid an average price of $31.84 per share. In the fourth quarter, as the financial crisis metastasized, the company issued $12 billion of stock at an average share price of $22.25. GE flooded the market with discounted shares. It was a failed attempt to protect its triple-A credit rating. GE shares trade at $13 today.
INSEAD Knowledge, an online education provider, examined 1,839 public companies in the United States over a five-year scale. It found that the more money a firm spends on buybacks, the less likely it is to grow over the long-term. It found 64 companies, including retailers The Gap (NYSE: GAP), JCPenney (NYSE: JCP) and Macy’s (NYSE: M), spent more buying back their stock than their businesses are currently valued in the market.
No company has more fervor for buybacks than Apple.
UBS believes Apple could buy $122 billion worth of its shares through 2019. It has already bought $150 billion since 2013. Apple shares are up 175% over the past five years. They’re up 600% over the past 10 years.
The research suggests that Apple management should rethink its buyback strategy for the sake of long-term shareholders. Those companies mimicking Apple’s buyback strategy might follow suit.