Company share buybacks gaining momentum
24 March, 2015
The global trend of companies buying back their own shares doesn't seem to have lost momentum. The latest figures from the US suggest companies fancy themselves as investments, do they?
That's right Larry. In the US alone during the last year companies have bought back over US$550 billion worth of their own shares.
It seems the larger the company, the stronger the trend — so virtually all the profits of the S&P500 (the index made up of the largest 500 companies in the US) were spent buying back their own shares and it is estimated that buybacks have contributed over a quarter of the earnings growth of the US market over the last couple of years.
Also, since 2010 US corporates have spent nearly US$3 trillion buying back their own shares. Now this is similar to the amount the FED have spent on QE — so I guess you could call share buybacks the QE of the equity market.
Why are they doing this?
When companies generate profits they have a number of options; they can pay back the profits to shareholders and they can do this through buying back shares (essentially this increases the earnings per share, so they are essentially paying back shareholders through capital gains), or they can distribute the profits as dividends, or the other option is to reinvest the profits back into the business (and that's to invest in the future).
The normal reason companies may decide to buy back shares range from:
- they think their share price is undervalued (and it's a good way to add value); or
- there are limited opportunities to invest; or
- the economic environment may still be uncertain; or
- they don't want to commit to dividend payments which can be quite sticky.
Which one of those factors is most likely?
In general, share prices aren't currently undervalued, so we can probably discount that one.
The global economic environment is still fragile and companies may be concerned about the long term growth outlook. But the fact is, these share buybacks are occurring as the US share indices are pushing new highs and when company valuations are relatively high compared to their history.
So there may be other factors involved.
What could the other factors be?
Activists and hedge fund managers have become quite vocal about share buybacks. The well-known US activist and billionaire Carl Icahn in particular has been aggressive in his attempts to get US companies to use their capital to buy back shares, and quite frankly it's been a winning strategy.
Since 2009, the S&P buyback index (and this is the index that is made up of companies with the highest buyback ratio) has outperformed the S&P 500 by 100% — now that's huge.
At the same time CEO's are receptive to the pushback by these activists and the cynic may argue that the trend towards CEO's staying in their roles for shorter periods, the fact that they now receive a lot more of their remuneration through shares and that their performance is measured on earnings growth, makes the idea of share buybacks a quick and easy win for them.
What about the impact on longer term growth if the company is returning profits rather than investing them?
That's the million dollar question. There is a real risk that many companies are now not investing enough in their future growth and this will have longer term implications for both their growth prospects and for their competitive position.
Classic case of underinvestment was smartphone maker Blackberry. They embarked on massive buybacks at the time Apple and Samsung were investing in developing new products and new technologies — look where that's got them.
However, it may be that companies are waiting for a less fragile global economy before they look to invest — it's hard to know for certain. But in the meantime, it appears that CEO's are happy to continue to return capital to shareholders via buybacks and generally the investors are rewarding them for it.