“It’s raining stock buybacks on Wall Street,” as CNN’s Matt Egan aptly puts it.
It’s about a week since Apple Inc. (AAPL) pulled off a once-in-a-lifetime feat by becoming the first U.S. company to achieve a market valuation of a trillion dollars. And now, another important milestone of the same dollar level is about to be achieved, this time by the entire stock market—hitting the $1 trillion share buybacks mark.
U.S. companies are buying back their own stocks at unprecedented levels, thanks in large part to president Trump’s $1.5-trillion tax bonanza. The overhaul lowered corporate tax to an average of 21 percent from 35 percent previously. The tax cuts have trickled right to the bottom line, with S&P 500 companies reporting an average 24 percent earnings growth during the ongoing earnings season, the highest clip in nearly eight years.
Keeping Markets Firing
Companies are returning a lot of those dollars to shareholders in a deluge of buybacks, with company boards having authorized $754 billion worth so far this year. Adjusting for the typical 85 percent follow-through rate, buybacks are likely to clock in at $640.9 billion, with 20 percent of S&P 500 companies yet to return their Q2 2018 scorecards.
That’s a huge 80-percent increase compared to the same period last year. At this rate, $1 trillion buybacks in 2018 is clearly in the crosshairs. That’s likely to have a positive effect on stocks markets that were already beginning to show signs of fatigue. Mutual funds have been seeing quite heavy outflows in recent months, with investors having pulled $57.1B from the retail sector so far this year.
Further, it could help lower volatility in critical sectors such as technology, which has been unusually jittery this year. Buybacks lead to higher earnings and boosts shareholder yields the same way dividends and debt paydowns do.
But more importantly, buybacks represent a critical source for stock demand given that other ownership categories, including mutual funds, pension funds and retail holders are net sellers of stocks.
Not Great for Future Growth
Investors rarely complain when companies engage in share repurchases. While the current year is likely to become a high watermark for buyback activity, the fact of the matter is that this has been an ongoing long-term trend.
Between 2006-2015, the 459 companies that consistently remained in the S&P 500 over the entire period expended $3.9 trillion in share buybacks, good for 54 percent of their total net income. In 1981, the S&P 500 spent just 2 percent of its profits on buybacks.
That’s a massive increase, which hardly comes as a surprise in this era when company executives are rewarded handsomely in stocks and therefore have a big incentive to push share prices up by any means.
Tech companies in highly competitive fields tend to engage in the practice the most, with many doling out huge stock-based compensation packages to top executives and staff to keep them happy and motivated.
But rewarding current shareholders so liberally can lead to a systemic extraction of value from companies on a macroeconomic scale. Throw in dividends and little is left for growth and expansion. For instance in 2017, the S&P 500 spent 50 percent of net income on buybacks and another 41 percent on dividends, leaving just nine percent for capex and things like R&D.
Democrats had earlier argued that the new tax legislation would only lead to an increase in share buybacks and wouldn’t do much to stimulate corporate investments as the Republicans hoped. Seems like they were right after all.
The floodgates to unbridled buybacks opened when the Regan administration removed a former impediment by the SEC and instead instituted Rule 10b-18 of the Securities Exchange Act. But that could change if Senator Baldwin’s proposed new bill, The Reward Work Act, sails through.
By Alex Kimani for Safehaven.com