The Great Buyback Surge Is Over: Corporations Are Once Again Net Sellers Of Shares
By now most are aware that the primary reason there was EPS growth last year (or the prior two years) was the relentless buying back of their own stock by corporate treasurers, accounting for 75% of the increase in S&P500 earnings per share even as revenues stagnated for the second year in a row and actual earnings growth was comatose at best.
At $500 billion in net stock buybacks in 2013, this was an immense amount of bidding power, equal to half of the Fed's entire annual liquidity injection. And while EPS was artificially boosted by an allocation of capital that most would say is the least efficient in terms of future growth (remember when companies spent on capital expenditures to fund long-term growth, not satisfy activist shareholders?) the only good thing that could maybe be said about the second highest annual corporate buyback in history was that companies still saw their stocks as cheap: after all, not even the most aggressive of CFOs would greenlight a massive buyback campaign if they expected their stock to plunge.
That is no longer the case.
As JPM's Nikolas Panigirtzoglou notes in his latest "Flows and Liquidity" weekly, "the S&P500 index Divisor rose in Q4 following a flattish pattern in the previous two quarters." This means that after buying back stock for rightly two years in a row, companies have once again turned to net sellers and as a result are increasing the divisor (aka the denominator in the EPS fraction) of the S&P500, which means two things: i) the boost to EPS from buybacks is now over and ii) even corporations view the market as overvalued and prefer to sell their stock rather than buy it.
This is how JPM's Panigirtzoglou see the development:
[One] measure of net equity withdrawal available on a higher frequency basis is the share count of equity indices. This share count is reflected in the so called “Divisor” of an equity index which roughly speaking is equal to the market value of the index divided by the price of the index. Divisor changes reflect changes in outstanding shares due to share buybacks or other corporate actions such as the ones mentioned above. But they also reflect addition or deletion of stocks to the index. If the S&P 500 closes at 1838 and one stock is replaced by another, after the market close, the index should open at 1838 the next morning if all of the opening prices are the same as the previous day’s closing prices. This is achieved with an adjustment to the divisor.
The Divisor captures the collective impact of share buybacks, share offerings, exchange of common stock for debentures, conversion of preferred stock or convertible securities, as well as stock options and employee stock programs. The Divisor of the S&P500 Index is shown in Figure 1. This Divisor experienced a big decline between 2004 and 2008 due to strong buyback activity. Between 2004 and 2008 it fell by 7% or almost at a 2% per annual pace of decline. It rose after Lehman due to large share issuance especially by financials and a drying up of share buyback activity. It started declining again in 2011 as share buybacks picked up. Between Q3 2011 and Q1 2013 the S&P500 Index Divisor was down by 2.2%.
But the trend started changing in Q2. The Divisor was little changed in Q2 and Q3 last year and rose modestly in Q4. There is little doubt that the increased pace of equity offerings is to a large extent responsible for the reversal in the declining trend. IPOs were up 140% from a year ago in Q4 while secondary offerings were up by 100%.
In the past, the decline in the S&P500 Index Divisor was used as a reason to question the quality of Earnings-per-share data. Academic studies have found that managers tend to increase share buybacks in periods of slow earnings growth to boost EPS via shrinking the denominator, i.e. the number of shares. Indeed all of the increase in the quarterly S&P500 Operating Earnings-Per-Share between Q3 2011 and Q1 2013 was due to the decline in the Divisor. There was practically zero “real” earnings growth over that period.
And judging by the record number of negative earnings preannouncements there won't be any growth not only in Earnings in 2014, but in EPS as well, now that the S&P as an entity is collectively a seller of equity.
To summarize: tapering has begun and according to many the Fed's injection of flow will completely end by the late summer; Goldman just said the S&P is overvalued by every measure, and we just learned that corporations are once again net stock sellers. Oh, and let's not forget the worst monthly payroll number in nearly three years.
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