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Low Rates Are Vital For Stock Buyback Party

By: Minyanville
Posted: 6/30/2014 3:03:00 PM
Referenced Stocks: MON;DIS;AAPL;IBM

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Yesterday, the Wall Street Journal published an interesting article about the power of share buybacks.

Jeffrey Kleintop, Chief Market Strategist of LPL financial, found that the biggest net buyer of stocks is companies buying back their own stock.

This ties in to some recent data we've discussed on the buzz.

Last Monday, FactSet reported [subscription required] that Q1 dividend and buyback activity reached $249.1 billion for the S&P 500 (INDEXSP:.INX).

Michael Sedacca subsequently pointed out [subscription required] that this number annualizes to $1 trillion, bigger than Fidelity's whole equity mutual fund business, which has $791 billion in assets.

And keep in mind, buyback money is fresh money, not the mere exchange of one stock for another.

Buybacks were $158.6 billion, and we can assume that some of the $90.5 billion in dividends paid was in dividend reinvestment programs or otherwise put back in the market.

According to FactSet, in Q1, free cash flow to equity (which reflects net borrowing) was up 9%. So even with low single-digit earnings growth, the buybacks (and dividends) can continue until we enter a real economic downturn.

Remember, when there are more buyers than sellers, stock go up, regardless of the underlying fundamentals.

Of course, this means it's absolutely vital that rates stay low:

1) Low rates mean lower interest expenses for net debtors, boosting earnings and cash flow.
2) Low rates make financing buybacks dirt-cheap.

Monsanto ( MON ) is the latest example of a company selling stock to fund a giant buyback, announcing last week that it raising debt to fund $10 billion of repurchases over the next two years. Disney ( DIS ), Apple ( AAPL ), IBM ( IBM ), and many others are executing similar strategies.

On a related note, low rates make acquisitions sensible for cash-rich companies. Earning near-zero returns on cash means there's a low hurdle to make a positive return-on-investment on an acquisition.

There's definitely a bubble-like flavor to this boom, but it's a boom nonetheless.

You can love it or hate it as long as you understand it.

Twitter: @MichaelComeau