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Long Story Short: Revisiting Stock Buybacks Six Months Later.
Waning Stock Buybacks: Should Investors be Worried?
(Note: companies that could be impacted by the content of this article are listed at the base of the story [desktop version]. This article uses third-party references to provide a bullish, bearish, and balanced point of view; sources are listed after the Balanced section.)
On April 3rd, Channelchek posted an article entitled “Stock Buybacks: Good, Evil, or Maybe Something In Between?” highlighting not only the significant rise in buybacks, but also the increasing concerns voiced by various parties regarding stock buybacks. Now, in a note to clients, Goldman Sachs recently warned that corporate buybacks are “plummeting” and it could have a big impact on the market. (1) According to the investment bank, in the second quarter of 2019 the S&P 500 share buybacks totaled $161 billion, about 18% less than the first quarter. Year-to-date, buybacks are down some 17%. For 2019, Goldman Sachs estimates total buybacks will drop 15% to $710 billion, with an additional 5% decline in 2020. (1) Assuming Goldman’s forecast is accurate, should investors be concerned?
Not All Buybacks Are Created Equal. Companies institute buybacks for a number of reasons, including a lack of viable alternatives for the cash, to offset dilution from options and restricted shares, and because management views the shares as undervalued, among other reasons. (2) With the stock market indices once again approaching all-time highs and well above beginning-of-year values, the recent decline in stock buybacks may just reflect a view by management teams’ that their shares are no longer as undervalued.
2019 Buyback Announcements Highlight the Diversity. So far in 2019, some 92 companies have announced over $350 billion of stock buybacks, according to MarketBeat.com (3). But diving deeper into these announcements highlights the inability to make sweeping statements about overall buybacks. For example, the 14 tech-oriented firms on the list account for over $153 billion of the $350 billion total announcements, and just four firms—Apple, Cisco, Microsoft, and Oracle—account for $145 billion of the announcements, or over 40% of all announced buybacks in 2019. What do these four firms have in common? Massive amounts of cash and short-term investments on the balance sheet, over $270 billion as of the most recent quarterly filings. Twenty-five financial firms account for an additional $95.2 billion of 2019 announcements. This means the other 53 firms announcing buybacks in 2019 accounted for only $101B, and nearly one-third of that amount is from four firms: Home Depot, Target, CSX, and Johnson Controls. (3) With so few companies accounting for the vast majority of buyback announcements in 2019, it would seem a stretch to place the overall market’s movements on such outliers.
It’s More About the Float. While the amount of stock buybacks has declined in the first half of 2019 and will be down for the full year, 2018 was a record year for stock buybacks, so some decline would be normal. In any case, a more accurate measure of the market is the overall float, which incorporates stock offerings, mergers and acquisitions, and option grants, among other items. Notably, the overall equity float of the market has declined in each of the past six years, with some years, such as 2015 and 2018 experiencing significantly higher declines than subsequent years. (2) The smaller float declines in years such as 2016 and 2017 seemingly did not negatively impact overall returns, as the S&P 500 was up 9.5% and 19.4%, respectively in those years. In 2018, the record year for stock buybacks, the S&P 500 declined 6.2%, while so far in 2019 the S&P 500 is up 19.9%, even while the level of buyback activity has declined. (4)
Buybacks Remain a Small Fraction of the Overall Market. Although buyback announcements seem large, see Apple’s $75 billion announcement back in April, as a portion of the overall $30 trillion market, stock buybacks remain a small fraction, suggesting that there must be other reasons than just buybacks to account for the market’s rise. (5)
Research Indicates Buybacks Are A Major Driver of Overall Returns. Research has indicated that over the last nine years the S&P 500 return would be somewhere between 2% to 19% lower without stock buybacks. (5)
Buybacks are Accounting for a Greater Portion of Earnings Growth. From 2001 to 2017, the average annual EPS growth in the S&P 500 was 6.9%, with buybacks accounting for just 0.2 percentage points of the rise. Over the last six quarters, buybacks accounted for between 0.8 percentage points to 2.2 percentage growth of EPS growth, including 50% of earnings growth in the first quarter of 2019 and all of EPS growth in the second quarter of 2019. (6) If stock buyback activity drops, will this put EPS growth at risk?
Timing Is Everything. Ultimately, for buybacks to benefit remaining shareholders, they should occur at less than intrinsic value. However, as the stock market has set new highs in 2018, so did the level of stock buybacks. (6)
Buybacks Lift Share Prices. By reducing the supply of shares, artificially boosting per-share earnings, and signaling management’s belief shares are undervalued, stock buybacks can provide demand for shares, lifting stock prices. (7) If the level of stock buybacks declines, the conditions for driving up share prices may disappear.
While stock buybacks have continued at a high pace in 2019, the amount of shares repurchased has declined from 2018 levels. Corporations are repurchasing their own shares at the slowest pace in 18 months. (8) Goldman Sachs’ estimate of total buybacks in 2019 has declined from $940 billion in May of the year (9) to $710 billion in October (1) However, buybacks remain a small faction of the overall market and are concentrated in a small number of firms, some of which have excessive cash hoards. While the projected decline in buybacks is unlikely to help propel the stock market higher, the downside risk due to such a decline remains uncertain.
- https://www.cnbc.com/2019/10/21/goldman-warns-buybacks-are-plummeting.html, Pippa Stevens, October 20, 2019
- https://www.marketwatch.com/story/heres-what-you-really-need-to-know-about-stock-buybacks-2019-07-01, Mark Hulbert, July 2, 2019
- https://www.marketwatch.com/story/how-much-lower-would-the-stock-market-be-without-corporate-buybacks-2019-05-02, Chris Matthews, May 2, 2019
- https://money.usnews.com/investing/stock-market-news/articles/2019-08-15/theres-a-worrisome-trend-in-share-buybacks, John Devine, August 15, 2019
- https://www.cnn.com/2019/08/22/investing/stock-buybacks-drop-tax-cuts/index.html, Matt Egan, August 22, 2019
- https://earlyinvesting.com/buybacks-drive-the-s-p-500-theyre-slowing/, Adam Sharp, August 30, 2019
- https://www.kiplinger.com/article/investing/T052-C000-S002-stock-buybacks-surge.html, Ryan Emery, May 9, 2019