Last Wednesday, some ostensibly serious people talked with [4] some openly unserious people about “obsessive” corporate buybacks when Moody’s head of leveraged finance Christina Padgett, told CNBC that her “concern would be—if you think about how a company should position itself for further growth, you want to think of them as taking the cash they do have and using it to invest in something that generates growth.”
By “growth,” Padgett was of course not talking about artificially growing EPS or growing executives’ stock price-linked compensation, but rather about growing productive capacity via capex (a term which is now a four letter word in more ways than one). Why would you not want to spend on productive capacity if you’re a company? Well it’s pretty simple: in the short-term, buybacks are a great way of driving up stock prices and making the bottom line look better than it otherwise would (and EPS beats are a great way of securing further stock price gains).
If you don’t believe us, just ask Barclays who, in a hilarious note from last month, spent 12 pages explaining that after extensive research, analysts had discovered that buying back shares is more effective at boosting stock prices in the short-run than is capex spending. Here’s more:
We find that the stocks of companies that invest in capital expenditures perform worse than the stocks of companies that repurchase their shares. In summary, capex is higher than ever, but it is not rewarding shareholders…
We created factors that rank companies based on their relative spending on capex, dividends, and share repurchases. Overall, these factors show us that the stocks of companies that invested a large portion of cash flow in capital expenditures performed significantly worse than companies that instead returned capital to shareholders through buybacks.
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So what you’re saying is that buying billions of dollars worth of shares is better for stock prices in the short-run than investing in future productivity? You don’t say. Of course the contention that “capex is higher than ever” is slightly misleading because while it may be at its highest level on record in absolute terms, a look at the following charts pretty clearly indicates that buybacks have the momentum.
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In any event, buybacks may be very effective at propping up stock prices and inflating EPS but what they can’t do is drive top line growth, which is why were not at all surprised to read the following from FactSet:
Overall, 201 companies in the S&P 500 have reported earnings and revenues to date for the first quarter. On the earnings side, 73% of the companies have reported actual EPS above the mean EPS estimate and 27% of the companies have reported actual EPS below the mean EPS estimate. The percentage of companies reporting
EPS above the mean EPS estimate is equal to the 5-year (73%) average.
However, on the revenue side, 47% of the companies have reported actual sales above the mean sales estimate and 53% of companies have reported actual sales below the mean sales estimate. The percentage of companies reporting sales above estimates is below the 5-year average (58%).
In fact, if 47% is the final percentage for the quarter, it will mark the lowest percentage of companies reporting sales above estimates since Q1 2013 (also 47%). Since Q3 2008, the percentage of companies reporting sales above estimates has finished below 50% only 6 times.
Due in part to more companies missing sales estimates than beating sales estimates, the blended sales decline is larger today (-3.5%) compared to the start of the quarter (-2.6%).
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There you have it. The picture of corporate health: the lowest percentage of companies reporting top line beats in two years.
The punchline is that the "record" amount of capex Barclays refers to has been overwhelming driven by one sector. We'll leave it to readers to assess the following graph and determine for themselves how likely that trend is to continue:
