Are Share Buybacks About To Hit A Brick Wall?

Tyler Durden's picture

With the Q2 US reporting season upon us, SocGen's quant research team focuses on the deteriorating state of corporate balance sheets in the US. Despite Intel going full retard on forecast buybacks, as we remarked numerous times, US firms are starting to show the strains of having to buy back $500bn of shares every year, whilst cash flows were under pressure. Leverage, SocGen argues, is starting to become an issue... and with it the ability to fund ever more expensive buybacks to maintain the illusion of EPS growth


Authored by Andrew Lapthorne of Societe Generale,

Companies are cash flow positive after investing and paying dividends (see above), but have a deficit when buybacks are taken into account. We estimate that non-financial S&P 1500 companies need to raise around $250bn per annum to make up the difference, which is what they are indeed doing – see below.

Of course as equities continue to rise, buying back shares becomes ever more expensive, so corporates will need to raise more and more debt at a time when the Federal Reverse is removing the punch bowl that is QE. Corporates, on aggregate, have shown little apparent regard to the actual execution price of their share buybacks, and the pro-cyclical availability of credit only exasperates the problem, i.e. credit is widely available when markets are at peak but hard to come by when markets are distressed and equity prices cheaper.

We do however find it somewhat ironic that, on the one hand, companies have been increasingly willing to divest assets (we assume because they can get a good price for them) and yet, on the other hand, continue to buy back their shares at an increasing rate with the proceeds. As we show below, whilst capital expenditure is barely growing, sales of investments is accelerating at 20% per annum. As a result net investment & acquisitions is falling at around 10% per annum.

The final point to make is that not all of these share buybacks are discretionary. As we show below, out of the $480bn spent on non-financial share buybacks over the last year, $180bn appears to have been spent on stopping the dilution from maturing stock options, i.e. the share count only came down by $300bn. The implication is that this $180bn is an ongoing cost for the firms in terms of staffing costs.

We’ve always struggled with the US accounting for stock options. As far as I can tell, option grants are accounted for in the income statement based on the option price at the time of the grant. However it is not clear if the firm then hedges this position by actually buying an option in the open market. Given the open declarations from companies that they are buying back stock to soak up the effect of options maturing, we’d suggest that in large part they do not. Investors are then on the hook for any future share price rises. So whilst the cost of these maturing options is recorded on the balance sheet and cash flow statement, it is not accounted for on the income statement. Please someone correct me if I’ve misunderstood.

Yet operating profit margin is defined as the proportion of a company’s revenue that is left after paying for variables costs of production such as wages etc. With that in mind we deduct the actual cost of maturing buy backs from US operating margins; they are nearly 200bp lower and look rather like European profit margins. Go figure.

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Irishcyclist's picture

Stupid question time.


Why are companies buying back their own shares? 

LetThemEatRand's picture

Not a stupid question, but a simple answer.  Executive compensation is largely tied to stock price.  Most CEOs and other executives receive huge bonuses and cash in on stock options when share prices rise, regardless of the reason.   Buying company shares with company money raises the stock price artificially.  Investors are happy in the short-term as a secondary objective, so everyone wins until the company runs out of money.  At that point, the executives leave (very wealthy) and go to another company to rinse and repeat.  The stock of the original company craters, and the former executives laugh.  Heartily.

Irishcyclist's picture


In my naivete I assumed that companies wanted to control further their own shares/stock.


Dead Canary's picture

Another point. If they invest money (borrowed at cheep interest rates) in capital expenditures and hiring employees (What the Fed said was the reason for cheap interest rates) and the economy doesn't turn around, that's money down the drain. However, if the economy DOES turn around, they have to pay taxes on the profits. It seems the CEO's of this country have no faith in a turnaround.

Safer to boost the stock price artificially. It's the next guys problem.

StacksOnStacks's picture

Not to mention it takes shares away increasing the Price to Earnings ratio causing idiots to think the company is doing better than it actually is.

max2205's picture

And if their bonds go down they book profits.....willywonka

Gromit's picture

So companies buy the shares to be redeemed against share options granted.

As long as cheap mony is available, earnings per share rise.

Untii it isn't then they don't.

Nick Jihad's picture

Ahh, but you are overlooking that golden day, when easy money will have finally given rise to the long-awaited Hockey Stick of surging GDP, and then Fat Margins that will drown all of our debts, woes, expenses, impairments, rehypothecations, etc, etc.

Duffminster's picture

What I am questioning is what appears to be an estimate by "economists" that Q2 GDP will be 3.3%.   This from Bloomberg:

"...Gross domestic product will expand 3.1 percent from July through December following a 3.3 percent advance last quarter, according to the median forecast of 74 economists polled by Bloomberg from July 3 through July 9. It would be the first time since 2004-2005 that GDP has sustained such gains over an extended period...."

Can someone tell me what data might be supporting this "estimate"?!!



ultimate warrior's picture

You sound cynical and Obama specifically said HOPE is the better choice.

So hope is supporting this estimate....move along now and stop asking questions slave.


daveO's picture

It's all thanks to firecracker sales at Elmer Fudd's tent on the edge of town.

JailBanksters's picture

As Iunderstand it.....

They are losing sales.

The death nell of any company is if it's worth less this month than previous months, so existing shareholders cut their loses. So you buy your own stock to push the price up to attract more shareholders.

It's a monster Ponzi scheme. The stock price is disconnected from the real health of the company. And every Major US Corporation is doing this.



daveO's picture

To enrich the handful of execs, at the top, who get most of their earnings via stock options where they buy for pennies on the dollar. The higher the stock, the better the payout.

JailBanksters's picture

Buybacks just another word for Ponzi, like all good Ponzi's once you start......


buzzsaw99's picture

we finally have the market the fed gangsters and billionaires have wanted all along. fake, inflated, rigged.

Seasmoke's picture

Who is going to be the next Madoff ? Who says that's it. No more. It's over. 

Kreditanstalt's picture

This is a "company-centric" analysis.

How many people actually work for big companies anymore anyway?

pitz's picture

Not many Americans.  The firms are mostly hooked on hiring foreigners on H-1B's and similar, while ignoring the resume queues of thousands of applications per position.  Quite a travesty that the government actually allows it to happen unfettered. 

Cursive's picture

Diminishing returns?  BernanQE banished those....


pitz's picture

Nothing wrong with share buybacks, but the problem is, the balance sheets really aren't as strong as people think (most 'cash' is actually pre-tax cash held by overseas subsidiaries, which must be heavily discounted if ever to be returned to domestic shareholders).   There is the spectre of much higher federal, state, and municipal income taxes hitting corporations hard as the need to bring government deficits under control in a rising rate environment becomes acute.  And a very large amount of the US economy is actually levered to low interest rates in 'consumption'-related industries. 

Firms that use their earnings to build leading-edge export-related capacity that cannot be easily duplicated/stolen by the Chinese, might actually do okay, but there's a lot of malinvestment otherwise in the US economy.  Which we see ample evidence of in the stock market when we look at technology companies with no earnings and quite minimal investment receiving sky-high valuations. 

orangegeek's picture

corps buying at tops


so when corps reissue shares to pay out when bonds are due, would that be selling at the bottom??


another bagholder that isn't a retailer.  funny dat.

moneybots's picture

"buy back $500bn of shares every year"


So what is all this debt going to do to public companies when the economy goes into the next recession?

pitz's picture

Many firms were/are legitimately under-leveraged, and definitely benefitted by taking on more leverage as the result of long-term appreciation of their assets relative to debts.  The problem is that you have a lot of companies out there that are basically sweet nothings, particularly firms that are engaged in marketing, sports, online advertising, amongst others, that possess no lasting and durable industrial capacity, loading up on debt.  These are the sorts of companies that are likely to have problems in a credit constrained environment. 

If we think of brands that were popular a hundred years ago, how many are still intact today?  Very few.  Heck, even on the Internet, leadership for search engines has changed a few times over the past 20 years alone.  So what makes anyone think that brands and minimal-asset companies are durable and credit-worthy over the long term? 

Shizzmoney's picture

This article alone proves ot move they will never raise interest rates; they may try, but then the market will tilt sell off and its NIRP here we come! 


MedicalQuack's picture

Walgreens buy back program, they need to finance it if they stay in the US and don't take the tax inversion..I read that a while back and what's a CEO to do?  If they stay then cut backs to finance stock buy backs, stores may close, people get laid off, but oh they are the heros they stayed in the good old we loose in the long run as jobs go away and some Mom with kids is out of work. 

If you are not Apple with a lot of cash, well something has to give when leveraged.