The impact of all this cash being returned to investors has been notable. According to a report by Aon Hewitt, the market has been a net seller of US equities over recent years and, had it not been for corporates buying up their own shares, there would not have been any aggregate demand and selling pressure would have pushed prices downwards.
FRIEND OR FOE…?
The investment case for companies engaging in buyback programmes is built on some strong arguments. Not least, they tend to outperform by a significant margin. While the S&P 500 has produced over 8% in annualised returns over the 10 years to 26 May 2015, the S&P 500 Buyback Index, by comparison, has clocked up annualised returns of nearly 12%.
In a low-return environment, where investors are keenly focused on generating income, that 4% differential per annum is difficult to ignore.
“Equity is turning into bonds as people look for income,” according to Patrik Schöwitz, global strategist in JP Morgan Asset Management’s GIM Solutions Global Multi-Asset Group. “The valuations of those companies relative to the rest of the market keeps going up.”
He argues the increased level of buybacks in recent decades has reduced the rate of shareholder dilution in many markets and boosted shareholder returns as each remaining share accounts for a greater proportion of the company’s earnings and dividends.
Barclays estimates on average companies in the S&P 500 have benefited from a 1-2% bump in earnings per share (EPS) as a result of buybacks. Meanwhile S&P calculates more than 25% of companies reduced their share count by over 4% in the 12 months to June 2014, resulting in a more meaningful 4% boost to EPS.
So, for those investors that don’t sell their shares back to the company, there is an increase in the EPS and share price (as aggregate demand is spread over fewer outstanding shares) to enjoy without an increase in profitability by the company being necessary.
But, as the old saying goes, there is no such thing as a free lunch.
WHAT GOES UP HIGHER MUST COME DOWN HARDER
Although they tend to outperform over the longer term, during shocks, they fall faster and harder. After peaking at 142.3 on 4 June 2007 the S&P 500 Buyback Index fell 56.1% to a low of 62.47 on 20 November 2008. The decline was 6.5% greater than the 49.6% fall seen in the S&P 500 over the same period. And again in 2011, when the S&P 500 Buyback Index fell 3.7% in less than two weeks from 159.26 on 7 July to 153.29 on 20 July, the S&P 500 fared much better, losing only 2% over the same period.
One of the key reasons for this is companies often use debt to finance share buybacks. During the early 2000s net buybacks and net debt among US stocks has been relatively stable, with both hovering around the $50bn mark. Leading into the 2007 crisis, however, net buybacks and net debt increased massively in unison to peak at around $400bn and $270bn respectively just before the crash, after which they plummeted back down to below $100bn for net buybacks and -$100bn for net debt by 2010.
Since then, both figures have begun a joint ascent once again, surpassing their previous peaks with net buybacks of US stocks back up over $400bn and net debt over $300m.
“The big change over the last couple of years,” according to The Boston Company’s Ferguson, “has been a dramatic change in the willingness of companies to deploy capital as confidence increases.”
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