Business | Your Money

Buybacks a factor behind stock market boom

Least appreciated reasons for rally is also one of the biggest

  • AP
  • Published: 18:34 May 26, 2013
  • Gulf News

New York: It’s the narcissist rally. Sure, there are plenty of forces pushing stocks higher - record corporate earnings, small investors finally buying again, signs the U.S. economy may be strengthening, central banks flooding the financial system with money.

But you may want to spare a thought, and a healthy dose of worry, for what is one of the biggest, and least appreciated, reasons for the rally: buybacks.

Companies are one of the few big stock purchasers nowadays. Nearly every other big player in the stock market has been selling more than they’ve been buying. Pension funds have been selling. Local and state governments have been selling. Investment brokerages have been selling. And, yes, until recently, even Main Street investors.

You can see this in the data released by the Federal Reserve each quarter, and it’s a sea of red - save for corporate buying, that is, buybacks plus purchases of other companies. In total, U.S. companies, not counting banks and other financial firms, have bought more than $1 trillion of stock in the five years through 2012, net of stocks they’ve issued.

Experts note that companies may not spend all the money they have authorized on buybacks. But with investors clamoring for companies to return cash to them, either in dividends or buybacks, the odds are high that many will.

However much they spend, each dollar of buybacks appears to be having a greater effect on raising the prices of certain stocks. That’s because fewer shares are changing hands each day. On Wall Street, it’s referred to as a “drying up” of liquidity. And like in any market, a purchase or sale when fewer people are trading can push prices up and down much more.

Stocks move up for all sorts of reasons, so the exact impact on prices of individual stocks when companies buy their shares is unclear. In any event, the total amount of buybacks doesn’t appear to be enough to have a big effect on the whole market. If companies in the S&P 500 follow through on their plans this year, the buybacks will amount to just 1 percent of total trading, estimates Robert Leiphart, an analyst at Birinyi.

Still, companies that do buy back their own stock are seeing prices soar, and almost immediately.

Stocks of companies that have authorized the 10 biggest buybacks so far this year have risen 2.2 points more than the S&P 500 in the week after their announcements, according to Birinyi.

Instead of getting excited, though, some on Wall Street are worried.

Gregory Milano, CEO of consultancy Fortuna Advisors, has run studies showing that companies that spend the most on buying back their own stock tend to underperform because they don’t spend enough on opening new factories, research or otherwise building their business for the long term.

Andrew Smithers, who runs a London-based investment consultancy, thinks buybacks have pushed stocks more than 40 percent higher than they’re worth. In his book “The Great Deformation,” former U.S. budget director David Stockman says Corporate America is drunk on buybacks and that they’ve helped push stocks up too far.

Another problem is that buybacks can give investors a false sense of strength of the true earnings power of a company. Forty percent of the increase in the earnings per share of S&P 500 companies in the past 12 months came from reducing the number of shares through buybacks, estimates Barry Knapp, chief U.S. stock strategist at Barclays Capital.

Even if you’re worried, it’s not clear what you should do in the face of this massive corporate buying, which shows no signs of easing. Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, notes that S&P 500 companies have plenty of cash to keep buying - a record $1 trillion, not counting money set aside in reserves as required by regulators.

The dilemma facing buyback skeptics who are thinking of selling is the same one facing those worried the rise in the market has come mostly from the Federal Reserve efforts to stimulate the economy. “Don’t fight the Fed,” the old Wall Street saw goes.

To which should perhaps be added, “Don’t buck the buybacks.”

their own reward

Flush with cash companies have decided there’s nothing more attractive than themselves. So, they’re offering big money to buy back their own stock. This year, big U.S. companies have given the go-ahead for $286 billion of buybacks, up 88 percent from the same period last year, according to Birinyi Associates, a market research firm. If the pace continues for the rest of the year, the tally will exceed the record set in 2007.

Every manner of company is caught up in the buying binge, including home-improvement chains, makers of farm equipment and jet engines, airlines, sellers of soft drinks and of hard liquor alike. Not one to miss a hot trend, Apple recently authorized as much as $50 billion of buybacks.

Investors like buybacks because they suggest companies think their stock is cheap. They also help reduce the number of shares outstanding, which automatically increases earnings per share. And higher earnings per share often, though not always, lead to rising stock prices.

Gulf News

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