Buyback Bubble?

Share buy-backs is the term used when a company buys back its own shares from either its free cash-flow or from borrowings, effectively stating that the company cannot find any better use for growing the business or reducing debt.

Whilst this has some merit during a period following a debt-induced financial bust, due to the over-capacity created during the prior boom and the low interest rate response to the bust, a cynic would observe that the shorter term earnings enhancing benefit from a buyback sits very well with management’s bonus conditions but not necessarily with the shareholder over the longer term.

The Bloomberg S&P 500 Buyback Index measures the performance of the top 100 stocks with the highest buy-back ratio, defined by “cash paid for common shares buyback in the last four quarters divided by the SPX total market capitalisation.”

8 Oct 14 Blog 1

As can be seen within the chart above, there has been a close correlation between the S&P 500 index and the buyback index, as stock repurchases totalled almost $US2 trillion since March 2009. The correlation has become even tighter since the 2011 correction low, as witnessed below.

8 Oct 14 Blog 2

However, this form of “financial engineering,” may have gone too far, as share buybacks now account for more than 30 percent of cash flow, almost double that seen in 2002, according to a Bloomberg report, whilst the portion used for capital spending has fallen to 40% from more than 50%, leaving companies with an average age for fixed assets at 22 years, the oldest plant and equipment in almost 60 years.

Of particular concern, however, is that buybacks and dividends have exceeded profits in Q114 and look likely to in Q314, according to the same report, noting that the last time this situation existed was in 2007.

Now what was it that occurred in 2007?

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2 responses to this post.

  1. […] the move lower as per one of our preferred indicators, Buy, Sell or Neutral, whereas October’s “Buyback Bubble” and “Red Margin,” warned on the distorting effect of US share buy-backs and on margin debt, […]

    Reply

  2. […] as we saw in the lead up to the 2007 bust and that of Japan way back in 1989. Our October 2014  Buy-Back Bubble expanded on this for the US, which is still the most important economy and stock-market in the […]

    Reply

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