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"The End Of The Road" - Debt-Funded Buyback Boosts Are Finite
Submitted by Lance Roberts via STA Wealth Management,
I penned an article recently discussing the many measures that corporations have used in recent years to "beat" Wall Street estimates. Of course, the beating of Wall Street estimates, so adamantly adored by mainstream media, always ignores the fact that estimates are continually reduced so that companies to "beat" them. This is the equivalent of moving the "target to the arrow."
This "target moving" can be clearly witnessed by the quarterly movement in estimates over time. Dr. Ed Yardeni regularly publishes the trend in earnings estimate revisions over time. From the initial to the final estimates, the overstatement has been roughly 33% on average.
Most importantly, notice that during the two "great bear markets," starting estimates continued the previous trend of "bullish hopes" that were quickly quenched by "bearish realities." In other words, Wall Street never saw the coming "bear markets" and led investors to their demise.
With estimates once again being ratcheted down to meet current economic realities, it is not surprising that forward expectations remain extremely optimistic. "Hope" springs eternal.
But, therein lies the problem. If we assume that an investment into the S&P 500 index was made at the beginning of this year, the valuation was 16.26x earnings based on the then estimated earnings of $126.57 for the year. As of June 2015, that valuation rose to 17.20x earnings, a 5.8% increase. The problem is that the valuation rose not because of a substantial increase in the "P," but due to a decrease in the "E."
Given the deterioration in the profit picture, by the time the end of 2015 arrives, the valuation of that investment is likely to be even more unattractive.
This brings me to the current problem. It is not just the deterioration in earnings that is concerning, but also the "quality" of those earnings. While there has been a consistent droning of articles and analysis suggesting profit growth is still strong, it is how those "profits" are being achieved that is concerning.
As I suggested above, corporations have been using a variety of measures from cost cutting to accounting manipulations to offset weak revenue growth. This allows them to play the "beat the lowered Wall Street estimate" game where the prize is elevated stock prices to support stock option based compensation plans.
One of the primary measures used to boost bottom line profitability has been "share buybacks." The reduction of the number of outstanding shares boosts the profits per share calculation.
This aggressive use of this tactic was brought to light recently in a Bloomberg article by Oliver Renick which stated:
"It’s official, using proceeds from debt sales to send cash to stockholders has never been more popular.
Standard & Poor’s 500 Index companies listed buybacks or dividends among the use of proceeds in $58 billion of bond deals in the past three months, the most on record, according to data compiled by Bloomberg and Sundial Capital Research Inc. More than $460 billion in repurchases were announced during the first five months of 2015, on pace to top last year’s record."
While there is much talk about the end of the "bond bull market," recent data suggests that this is far from the case. Investors, yield-hungry in a near zero interest rate environment, remain eager buyers of any and all debt issued, even if that debt is "junk rated."
That debt issuance has led S&P 500 companies to repurchase $2.7 trillion in shares during the last six years. That frenzy to repurchase shares has been a primary support for the second longest "bull market" since the 50's.
"An S&P 500 index measuring the performance of the top 100 stocks with the most buybacks has added 13 percent in the past year, compared with an 8.3 percent gain in the benchmark index."
The chart below, courtesy of Goldman Sachs, shows that stock buybacks as a percent of total cash use has reached the highest level since 2007.
Of course, it is not just the overall increase in stock buybacks that is concerning, but the surge in buyback announcements. The rush to market suggests a near "panic" by companies to take advantage of both low rates and investor appetites. The chart below, courtesy of Deutsche Bank, should elicit some concern.
The problem for investors is that inorganic measures to boost profitability, like cost-cutting, wage suppression, layoffs, and stock buybacks, are finite in nature. Eventually, these options are exhausted. There are only so many employees that can be terminated, wages can only be suppressed for so long, and there is a finite number of shares that can ultimately be repurchased from shareholders.
The question that investors need to be asking is what happens when companies inevitabilty reach "the end of road." Importantly, with the Fed determined to begin hiking interest rates, despite weak economic data, the end may be nearer than most are currently expecting.
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Prices go up.
I give you two thumbs up for your cynicism.
with the Fed determined to begin hiking interest rates
the Brooklyn Bridge is yours for $10
@Justobserving
I would accept 1oz of silver for selling Brooklyn Bridge........................$10............no
Bullshit, so long as people still accept that paper/digits it isn't over...
tick tock..
Those pesky debts from all those buybacks will magically be paid using the new Ponzi accounting methods. It can't go on but it cannot stop.....
End of the road? Does that mean some sort of helium-filled air-bag will pop up and encase us, so we might just remove ourselves quietly from the scene of accident without any further notice of the mess we created? Right? ;)
It gets so F'ing old seeing these guys wank back & forth about what may happen or what may not... Does this sort of mental chart-masturbation keep their client base titilated until the next 'episode'...?
Right...and Greece is going to default. Give me a break.
The END should have been in 2007 when the TBTF should have been allowed to die. I am now convinced that as long as there are still Demicans & Republicrats being puppetted by the Oligarchs that all we're going to see is this never-ending fiat printing and can-kicking with no repayment of capital EVER.
suggest everyone go long in nails, guns, brewers yeast, distilling equipment and ammo
They are finite as government debt. It all depends on who is making the rules and their ultimate intentions.
Clearly buybacks are supported and most likely instigated by the international investment banks.
Cede and company owns ALL electronic equity shares. People who think of themselves as investors are merely beneficiaries of those shares (unless they own a hard copy certificate). Cede is owned by the Fed (or a close approximation)
One has to ask: "where is this headed?". Is it headed to a point where the banks and their cronies will be beneficiaries of such a large percentage (at whatever price, it won't matter at that point) that they can force private ownership of all companies (by them). They can force the surrender of all other beneficiary shares if they like. They will be the owners of the world ... or maybe they think they already are and just want to make it officially proclaimed.
Stock buy backs are enabled by ultra cheap money supplied by the FED (ie, US taxpayers). When TPP passes, more US workers can be laid off and the stock market can shoot up some more.
Sick and tired of ZH headlines such as this- Buybacks are finite- then no details or new insights on this concept, other than a restatement at the end that they are finite.
They are fishing ... as with most ZH articles these days. They are fishing for people and insight.
An issue with power is the one thing they value most and are least likely to recognize (take the word as you like it) is "insight".
Stock buybacks are a form of monetization by the CEO class. They convert their version of fiat currency (ie their stock) to another fiat currency ( the dollaro). The FED is cool with this you haven't heard a peep out of the CEO class because the FED has suspended normal accounting rules and is paying them to keep their mouths rich and shut.
As long as the after-tax cost of debt continues to remain lower than these companies' earnings yields, they will continue to fund the buybacks this way. Rising interest rates would help choke this off for sure.
HAHAHAHA, OH THERE’S A TOTALLY DIFFERENT WAY NOW!!!
Executives get their bonusses by quarter.
So, they pimp the number and kick the can on costs. And in 1 of the 4 quarters, the unleash all the costs and numbers are terrible, but 3 quarters a really good.
So 3 out of 4 bonusses and people just think they’ve have a bad quarter. Probably during snowing season or in the summer when it’s warmer.
Like the french say: Les excuses sont pour s’enservir.
Here are some more signs of a coming recession.
http://michaelekelley.com/2015/05/29/mergers-and-acquisitions-set-record...
http://michaelekelley.com/2015/02/20/fed-warns-of-two-bubbles/
http://michaelekelley.com/2015/02/24/would-you-pay-39-more-than-asked/
Here is the starting point.
http://michaelekelley.com/2015/04/28/next-recession-will-start-with-this-country/
Here is how to prepare.
http://michaelekelley.com/2014/10/16/8-things-to-do-when-recession-happens/
Here is how to get your mind off this stuff.
http://michaelekelley.com/category/humor/
Good luck!
If a company I own stock in, buys back all of the shares, It appears that I have made a profit.
I don't see a problem.
If the company goes bankrupt from the issuance of debt to purchase its own shares at exaggerated prices, then both you and the company's employees have a problem.
The process of incorporation is a mechanism, established in law, that enables entrepreneurs to escape personal liability in the event of bankruptcy. This provision gives tremendous advantages to corporate executives and boards in the assumption of risks, which enable them to expand their businesses, and for which they should be grateful to the enabling jurisdiction. But, of late, corporate executives and their boards have shown precious little gratitude to their charterers - the public - and have sought out every opportuniity to maximize their own incomes. The borrow-and-buyback program in corporate stock is one of the more blatant examples of this attitude. The governmental entity charged with issuing corporate charters should demand and legislate compliance with a corporation's threefold responsibility: to its stockholders, employees and customers. It is a joke to assign this heavy responsibility to the legislature of a scarecrow state like Delaware. Corporations of a certain size should be required to obtain a federal charter, the provisions of which can be monitored by a federal agency asigned to perform this oversight.