Wall Street strategists try way too hard to deliver a precise
forecast of where the
is headed. They look at price-to-earnings (P/E) ratios, projected
yields and other measures to come up with a target price for
They're wasting their time.
The actual price of a stock is determined far more simply. You only
need to focus on the supply and demand for stocks.
For example, the investment firm Liquidity Trim Tabs looks at how
much money investors have poured into
on a daily basis. On days when funds come into the market, the
market typically goes up. The reverse is also true.
Yet as we've seen the last few years, most investors have been
pulling money out of equity funds, parking their money in places
funds. Analysts at JP Morgan note that individual investors have
pulled $370 billion out of equity funds since 2007. That should
have led to a stock market pullback during the past two to three
years, but the opposite has been true. The market has tacked on
major gains in the current multi-year rally.
How do you explain the anomaly? You have to look at the supply side
of the equation as well. Thanks to a wide range of stock buybacks
(partially offset by new stock issuance from IPOs and secondary
offerings), the supply of stock available for sale is now back down
to 2006 levels, according to an analysis done by Bloomberg.
JP Morgan suggests companies have bought back three times the
amount of stock that individual investors have sold, implying that
supply is shrinking much faster than demand.
The trend continues in 2012
Even as the
market starts to heat up in 2012, creating a greater supply of
on the market, the
of stock buyback activity appears to be far higher. Young companies
are issuing a few hundred million dollars in stock, but many blue
chips are buying back billions of dollars in shares.
This table below looks at the biggest buyback announcements of just
the first 10 weeks of 2012.
You're looking at roughly $75 billion in stock being taken out of
the market by these 24 companies alone (which ignores current major
buyback programs that were already in place before the year began).
Some of this robust buyback activity can be attributed to interest
rates hovering at generational lows. A number of companies such as
, for example, have taken out loans simply to buy back stock.
Timing and buyback size are everything
Of course, many of these companies may be making a huge mistake if
there shares are already near multi-year highs and their P/E ratios
aren't especially cheap. Case in point: Companies in the S&P
500 earmarked roughly 35% of their 2007
to buybacks, only to find their stocks plunge to much lower levels
in 2008, after the buybacks had been completed. Had they waited
until the market tanked, they would have shrunk their share counts
much more aggressively.
Some companies may eventually regret parting with so much cash.
Cable operators like
Time Warner Cable (NYSE:
are buying back huge chunks of stock, even though
dark clouds are starting to gather
over their industry.
You shouldn't necessarily see these buyback programs as an
inducement to buy, either. Tech stocks like
Motorola Solutions (NYSE:
are buying back stock because they have too much cash, not because
they are bargains. Each trades for more than 15 times projected
I like to focus on stocks that have a chance to reduce their share
count by 10% or more, such as
Applied Materials (Nasdaq:
. Each stock trades below the broader market multiple of around 15
What it means for the market
Regardless of what buybacksmean for a particular stock, it's an
unequivocal positive for the market. With fewer shares in play,
earnings per share could spike to record levels when the
Home Depot (NYSE:
as an example. The do-it-yourself home improvement retailer had 2.3
in 2004, but after years of buybacks, that figure has shrunk to
1.56 billion. Back in 2004, Home Depot earned $1.89 a share. With
today's lower share count, that
figure would have been $2.82. Coincidentally, that's about what
Home Depot is expected to earn this year because
is far lower than it was back in 2004.
But what happens when the housing market improves and profits rise
back to 2004 levels? Home Depot would earn closer to $5 a share --
a company record, by far. Home Depot could have been more effective
at buying back stock only when shares were in a funk, but the
company will still reap the benefits of 700 million cut in the
And as long as the supply of stock remains restrained, the seeds
are sown for further market gains down the road. J.P Morgan thinks
of buybacks as "
fuel as investors will ultimately move back into equities." They
favor financial services stocks, which are already inexpensive,
compared with the rest of the market, and thus could have a more
dramatic impact on their share count if more shares are bought
Risks to Consider:
These big buybacks would prove foolhardy if they are completed
just before the next market downturn.
Action to Take -->
Boosting earnings is one thing, but lowering the denominator
(number of shares) in calculating that all-important EPS figure is
also a solid move. And when the numerator (earnings) rises higher,
EPS can really shine. Be sure to sort through the stocks in your
portfolio to see how any buyback plans will affect the stock. And
don't forget to consider this when making any new purchases.
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of HAS in one or more if its "real money" portfolios.