Share Buybacks Turn Toxic

Wolf Richter's picture

By Wolf Richter, WOLF STREET

Companies are still borrowing and spending billions on buying back their own shares – one of the big drivers behind the blistering stock market rally of the past few years. It worked wonderfully and without fail. But suddenly, it’s doing the opposite, and now the shares of the biggest buyback queens are getting hammered. Something broke in the gears of this financially engineered market!

During the November-January period, 378 of the S&P 500 companies bought back their own shares, according to FactSet. Total buybacks in the quarter rose 5.2% from a year ago, to $136.6 billion. Over the trailing 12 months (TTM), buybacks totaled $568.9 billion.

That’s an enormous amount of corporate cash that was dumped on the market!

The sector that blew – “blew” because that’s how it turned out – the most money on this type of financial engineering project was Information Technology, with $33.2 billion in buybacks last quarter. Four of the top 10 buyback queens were Information Technology: Apple, Microsoft, Oracle, and Visa.

Apple alone blew $6 billion in the quarter, even as its stock was tanking. Relative to its average share price over the period, it paid a 13% premium, the second highest premium paid by S&P 500 companies, after Symantec! Over the trailing 12 months, Apple blew nearly $40 billion on buybacks, and yet its stock dropped 15.5%.

This table shows the top 10 buyback queens in order of the amount spent on a TTM basis, and the mostly dismal performance of their shares over the same period.

US-Buybacks-top-10-TTM

GE didn’t quite make this list (though it bought back $3.1 billion in Q4), but it was very active in different ways, following through on its $50-billion buyback program announced in April last year. FactSet:

In addition to the repurchase program, GE completed a stock swap with the former GE Capital retail finance division, Synchrony Financial, which had an effect on shares outstanding that was equivalent to a $20.4 billion buyback. As a result, the shares outstanding for GE were reduced by 6.7% in the last twelve months.

Total buybacks are ballooning in proportion to net income, which declined over the TTM period for the first time since 2009. So buybacks as a percent of income rose from 64.9% a year ago to 68.1% at the end of the quarter. In terms of free cash flow after dividends, share buybacks have now ballooned to 101.7%. This was, as FactSet put it, “a huge jump from the year ago quarter when the ratio was 81.6%.”

The culprit? With income down over the TTM period, aggregate free cash flow has dropped 9.5% year-over-year.

FactSet’s chart shows the declining net income (green bars), the nearly flat share-buybacks (blue bars), and the rising buyback-to-income ratio (red line, right scale). Note what happened last time income began to decline (2007) and share buybacks followed in 2008: the stock market crashed.

US-Buybacks-to-net-income-2016-03-ttm

And yet, despite the current heroic efforts to prop up their shares, companies have seen their shares get hammered.

As FactSet’s chart below shows, over the past 12 months, the S&P 500 total return index, which included dividends, rose 1.3% (green line). But the total return of SPDR S&P 500 Buyback ETF, which tracks the 100 companies in the S&P 500 with the highest buyback ratio, dropped 7.6% (blue line):

US-buyback-v-sp500-stock-performance-2015-03-ttm

Clearly, financial engineering is kaput! Buybacks no longer function reliably in inflating stock prices. The opposite seems to be happening. Perhaps investors are finally starting to see through these shenanigans, and perhaps they’re now beginning to fret about all the debt these companies take on in order to fund buybacks!

When companies borrow billions to then blow that moolah on buying their own shares that then promptly decline in value, it doesn’t create a loss on the income statement. Instead, those billions quietly go up in smoke. What’s left behind? Fewer shares outstanding, piles of additional debt, mauled cash balances, and much higher financial risk.

But once companies see that share buybacks are becoming toxic as their shares decline despite buybacks, they curtail them. And last time this happened – in 2008 – it pulled the rug out from under the already teetering markets.

The bull market from early 2009 into May 2015 looks just like every bubble in history, and there’s one sign after the next that we did indeed peak last May. The dominant pattern in the stock market is the “rounded top” pattern. Read…  This Chart Shows the First Big Crash Is Likely Just Ahead

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lasvegaspersona's picture

These numbers are staggering!! Companies using most (or more than) their profits to buy their own share even as they lose money doing so. It is just amazing!

All the talk of 'cash on the sidelines...no talk of debt on the sidelines however.

The public is completely unaware of this. No one I speak to has a clue (but I'm a doctor not a banker or in retail).

When this thing snaps the public will not be able to understand. ...but the markets were doing so well....

Arthur's picture

Are they retiring the shares or still carrying them on the books?

Makes an accounting difference on how the repurchased shares are treated on the books.

scraping_by's picture

A lot of shares are reentering the market when C level executives cash out their stock option bonus. Then bought by the company because eight-figure cash salaries look bad.

new game's picture

some call it goodwill, like a donation to the blackhole.

kenny500c's picture

When losses arise these buybacks will make loss per share larger due to a reduced share count.

Also, when shares are brought in don't they affect the balance sheet if the share price declines?

neidermeyer's picture

They become "shelf stock" , equivalent of "authorized but unissued" ,, the only advantage is that they no longer must pay the dividend (if applicable).

Kefeer's picture

The market goes where they put it; period.  Unless something breaks that cannot be fixed and/or hidden, then I suspect record highs because it is a Presidential election year and you can't make the first Kenyan President look true to his colors.

In the shadows, right now, Douche Bank is being unwound will the help of the BIS.  If it imploded, then all would implode.

Baa baa's picture

I agree. The chart currently shows ample wiggle room that remains exploitable. I do not see this in  2009.

Help please?

Pretty Vacant's picture

Math is hard.  Stock buybacks are supposidly driving the market higher.  Yet, this article indicates coporations which engage in buyback activity instead underperform the market. Therefore, logically, buyback queens are impeding the market by slowing the advance of the subject firm's equity prices.  HUH?

scraping_by's picture

@Pretty

The original theory was buyback demand added to retail demand and speculative demand.

However, retail has left the buidling and they ain't coming back. Speculators were never a very big part of the market, and even though they have unlimited supplies of other people's money for free, they're not trading furiously, either. Buyback demand is pretty much the only one left, and it's not enough to bid up the bidding up of the bidding up. So, a lot of supply out their just sitting in stockbroker's vaults.

kenny500c's picture

It implies business is bad so there is no use in expanding the business. 

DownWithYogaPants's picture

Good Question - Good answer 

And now there is the rest of the math: The money cycles into the market created by fiat loan. It cycles rapidly out of the sagging stock through a sell and back into the market buying something that is going up.  

That would explain the rising market  and the falling buyback stocks.  

RougeUnderwriter's picture

Isn't the weighted averaeg cost of capital gernally higher to support stock than debt in this market?  That said wouldn't buy back then be positive?

 

Seagate's picture

Cost of capital is a relative term.  It usually refers to the cost of acquiring capital goods like land, buildings and machinery. The cost refers to the expnese associated with funding capital goods acquistion.  Selling stock is a balance sheet function and has little cost.  That is there is no interest to pay.  Preferred shares do come with an expense of dividends clothed as interest payments.

The cost of capital usually reders to the cost of borrowing money.

Conax's picture

"Fells Fargo"?

That's appropriate I guess.

PlayMoney's picture

Wondered why Jamie Dimon spent so much on personal stock purchases....until a month or so later JPM announces a big buyback. Thus inflating his recent purchase....should be a law against that. Criminals.

new game's picture

what is missing here is stock optioned stock being sold right about now. my guess is it rising and peaking soon. they know wtf is coming down and are basically cashing out. 10 million, 50 million, 2 million. yea, all leagal, but that is the game, do the time, grind to the top, cash out the options and live the life.

fucking corporations. and the majority get what 15/hr-30. they get millions. not saying some of these fucks aren't very intelligent people well deserving of their rewards, but really, millions while the serfs make squat...

jmfo

marathonman's picture

So these idiot CEO's bought all the way up and now have blown all their cash on buying their equity at the top just in time for the meltdown. It was obviously an egregious reach around to the CEO and their minions at the top on the board and now it is blowing up like Ackman's hedge fund.

I'd say they deserve what they have sown, but it's the rest of the employees that will get wiped out in this disaster. The CEO's will just get a rich buyout and go home.

KnuckleDragger-X's picture

I keep telling people, even at ZIRP rates, the money eventually has to be paid back. The economy has sucked for years, but the buyback fig leaf is getting very small.......

GotGalt's picture

KnuckleDragger - in a rational world, yes, one would expect all money borrowed to be paid back.  However, we live in an irrational central bankster led world where all debts never get paid back.  Instead, they either get rolled over (at lower rates) for credit worthy companies or else play the 'extend and pretend' game for non credit worthy companies.  More debt = more (pretend) growth for the fractional reserve banking system led atrocity known as the global economy.