One question I, as an equity analyst, always asked company
management publicly, sometimes even if I knew the answer, was about the status
of announced buyback programs and how they were financed. To me, the action was
an important enhancement to shareholder value, as well as an essential offset
to EPS dilution. Now, as in past years when buybacks were considered almost
illegal, questions have emerged from politicians and academics regarding buybacks’
suitability to corporate health and even social justice.
Edward Yardeni and Joseph Abbott have created an easily readable and convincing treatise that substantiates the workings of stock buybacks while weighing the arguments against them. The resulting work is a delight to read and one that educates the most seasoned equity analyst and investor. Enhanced in particular by the illustrative charts in its appendix, the book proves to be a page turner for investors, while also serving as mandatory reading for global investors to prepare them for the 2020 US election.
Stock buybacks continue to be misunderstood. A number of
academics and politicians (including some potential US presidential candidates)
state that buybacks have produced excessive leverage among the companies using
them, creating debt levels that could make them financially vulnerable in an
economic downturn. We sense that more cyclical industries, such as airlines, are
more subject to this risk than less cyclical (and potentially trade sensitive)
ones, such as information technology.
Many also question the raison d’etre of the bonanza of stock buybacks that occurred after the 2008 global financial crisis. They totaled $3.2 trillion from Q1 2009 through Q4 2018. The authors dispute the suggestion by some prominent academics that these buybacks were a form of stock price manipulation that accounted for the stock market’s massive gains over the same period. The rise in market capitalization of all equity issues in the United States totaled $27 trillion, far exceeding the value of stock buybacks. Yardeni and Abbott attribute the stock market’s huge appreciation to rising profitability and cash flow, as well as a wide spread between the S&P 500 Index’s forward earnings yield and the after-tax cost of borrowing in the corporate bond market.
The authors repeatedly state what they consider to be the main purpose for stock buybacks, no matter how they are financed: to offset dilution arising from employee stock compensation. Employee ownership is significant, according to sources the authors cite: It covers almost 20% of the total workforce and almost 35% of employees of companies that have stock benefit plans.
The belief that stock buybacks beef up EPS and reward the “fat
cat” executives is also a fallacy. Why? The authors prove again and again, via painstaking
mathematical work depicted in their charts, that over time, the difference
between growth in net income and growth in EPS that can be ascribed to buybacks
and net stock issuance is minimal. The spread between the growth rates of the
S&P 500’s EPS and its aggregate earnings has been tiny since the start of
available data in 1994.
The authors clearly address one exception — the substantive increase in S&P Information Technology (IT) sector EPS in 2018, which they consider an outlier. In that instance, reductions in shares outstanding boosted the S&P IT EPS by 14 percentage points. As noted in an article published by Bloomberg, “the top 10 U.S. tech companies spent more than $169 billion purchasing their shares in 2018, a 55 percent jump” from 2017. In previous years, however, the share count declines did not add much to EPS for this sector.
Those who have read Yardeni’s Predicting the Markets: A Professional Autobiography understand the importance of the Federal Reserve’s Financial Accounts of the United States to his ongoing research. He and co-author Abbott track the supply and demand for corporate equities using the Fed’s data but contend that its equity issuance measures for 2018 may not be appropriately accounting for public corporations’ stock issuance to employees. The Fed’s figure for net repurchases of stock in 2018 is 120% higher than the Yardeni team’s!
Stock Buybacks: The True Story is likely to inspire readers to apply the Yardeni team’s approach to complex economic and financial analysis to their own strategic thinking and investment decision making. The authors could potentially follow up with a fuller discussion and analysis of debt taken on by corporations to execute stock buybacks. Some may consider this dreary accounting, but it would paint a richer picture of corporate actions taken in an environment of falling interest rates, when the economy recovered, earnings and dividends grew, and capital spending solidly expanded. (See Ed Yardeni and Debbie Johnson, US Economic Indicators: Capital Spending in Real GDP, 27 September 2019.) This analysis could prove a valuable sequel to the Yardeni team’s current focus as corporate earnings growth faces the challenge of a decelerating global economy.
If you liked this post, don’t forget to subscribe to the Enterprising Investor.
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images/Buena Vista Images
Continuing Education for CFA Institute Members