Wall Street analysts have been suggesting that stock buybacks have been keeping stock markets moving up for some time now. With net buybacks by U.S. firms approaching their 2007 peak, it is therefore an ideal time to discuss several myths about buybacks.
A January 8th report from Deutsche Bank Research, authored by Chief Strategist Binky Chadha and team highlights the integral role stock buybacks are currently playing in our demand-supply framework for equity price returns, and also proffers five myths about buybacks.
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Myth No .1: Buybacks are approaching a peak. While buybacks are approaching their prior peak in dollar terms, viewed as payouts from earnings (which are now 25% higher), there is still lots of room for still more buybacks.
Myth No. 2: Most buybacks are being financed by the issuance of debt. In fact, S&P 500 operating cash flow currently covers dividends, capex and buybacks with a little left over. The share of companies issuing debt to cover payouts in excess of free cash flow has been moving up, but the current total of around half of the firms is far short of earlier cyclical peaks.
Myth No. 3: Stock buybacks will stop or shrink dramatically after the Fed starts raising rates. Given that buybacks are cyclical payouts, they often rise with policy rates, as they did during the last two rate hike cycles.
Myth No. 4: Buybacks are being undertaken at the expense of capex and dividends. The fact of the matter is that capex, dividends and buybacks have all been moving up. Chadha et al suggest that stock buybacks are just more cyclical: “they were cut by more in the recession and have consequently been growing faster since.”
Myth No. 5: Earnings per share growth is almost all attributable to buybacks. In fact, given the average 6.3% a year of S&P 500 EPS growth in the current cycle, the Deutsche Bank team estimates that buybacks contributed close to 1.6% a year. That means that three-quarters of EPS growth was not related to buybacks.
Outlook for stock buybacks in the S&P 500
The DB report notes that net buybacks for 2015 ($445 billion at recent run rate) were essentially flat compared to 2014 ($450 billion). The rather large reductions in the commodity sectors (notably Energy and Materials) were almost fully offset by an increase in buybacks in other sectors. The DB team is projecting a “modest (1-2%) increase in the total as non-commodity sector buybacks grow in line with underlying earnings (8-10%) and commodity sector buybacks fall further.”