There are two things we can say for sure about share buybacks:
1) based purely on equity flows, they have dominated equity markets since at least 2000
2) based purely on the reduction of share count, and assuming no increase in leverage, as is indeed the case for most of the largest share buybacks, they push up the price of shares
The verdict is out on whether they contribute to lower capital spending, and indirectly cause stagnant employment and wages. Given the supremacy of the shareholder primacy doctrine, I would be surprised if the latter does not hold (that is the whole point, in fact, even though, if every company targets lower employment costs, the cumulative effect on the economy would be lower aggregate demand, thus indirectly lower long-term company profitability), while it would be irresponsible if the former does, given that this ultimately cuts long-term profitability prospects.
Given the record amount of investor equity outflows, the record amount of company share buybacks and the near vertical rally in US equities since the beginning of the year, we can finally put to rest the hypothesis that it is share buybacks that drive primarily equity performance. This is indeed the conclusion that sell-side analysts have come to recently (see Citi, JPM, GS), based on equity flows, notwithstanding that when I was at HSBC, we came to the same conclusion three years ago. It stands to reason then that as S&P companies enter their blackout period en-masse starting next week and going into the middle of April, we should expect equities to lose some ground.
Things are a bit more nuanced though. The biggest mistake people make when analysing buybacks is that they look at the whole market and use averages. You want to understand the effect of buybacks, look at the companies doing the buybacks.
- Only 13% of publicly listed companies engage in share buybacks.
- Of those, the largest 20 companies constitute more than 50% of all buybacks.
- Of those Apple alone constitutes about ¼ of the total amount bought back.
The high concentration of buybacks among very few of the largest US companies guarantees their outsize effect on US equity indices performance while at the same time plays down their effect on equity fundamentals when looking at indices averages.
One unifying feature of the companies doing share buybacks is that their share count ends up substantially reduced. This is in stark contrast to the general market where share count is more or less flat to slightly down over the last 20 years or so. Over the last 5 years, the combined share count of the 20 largest share-buyback companies decreased by 11%. But there are wide variances amongst them. The biggest buybacks naturally reduce the most the share count. For example, Apple’s share count decreased by 23% and Boeing’s (5th largest) decreased by 24%.
There are two exceptions. Broadcom authorized $12Bn in buybacks in 2018 but over the last 5 years its share count has actually risen by 71%. And Micron Technology had a $10Bn buyback programme in 2018 but its share count has increased by 16% over the last 5 years.
Another unifying feature of the companies doing share buybacks is that their share prices tend to rise over time. The causation is a lot more difficult to prove given that over the last 5 years the general stock market is also up. But still, the average share rise of those 20 companies is almost double the rise in the S&P Index over that period.
And again, there are two exceptions. Qualcomm share price has decreased by 28% over the last 5 years despite its share count down by 17%. And ConocoPhillips lost 4% of its value while its share count went down by 5% over the period.
Do share buybacks ‘cook’ the books. Difficult to say using averages even on those 20 companies. Indeed, of those 20, on average top line growth is smaller than bottom line growth but is this from reduced share count or as a result of expanding profit margins due to cost cutting, for example? One has to dig deeper into the numbers on individual basis. Apple’s and Cisco’s Revenue growth is about half its EPS growth; Intel’s, Texas Instruments’, Amgen’s equivalent is between 3x and 5x smaller; yet Qualcomm’s, United Health’s and Wells Fargo’s Revenue is about 1.5x bigger than its EPS growth rate. And still others, like PepsiCo, Pfizer and Nike, have a negative Revenue growth rate but a positive EPS one. Finally, both ConocoPhillips and Merck have negative growth rate for both top-and bottom-line numbers.
Do share buybacks happen at the expense of capital investment? Again, difficult to judge even from these 20 companies without digging into debt, FCF etc. or other specifics. On average, capital spending growth over the last 5 years is in line with Revenue growth and below EPS. But there are, of course, outliers. Qualcomm, 3M, Adobe and Cisco have a negative capital spending growth rate despite positive Revenue and ESP growth rates. Oracle and Texas Instruments have double digit capital spending growth rates despite small single digit Revenue growth rates.
A few prominent people in the markets have written in support of buybacks and playing down their role in analysing US equity performance, but having looked at the numbers again from the bottom up, I cannot help but disagree with their conclusion.