Is one of the U.S. stock market’s main support pillars quietly crumbling? Since the financial crisis, companies buying back their shares have been among the biggest drivers of the equity markets’ advance to record highs. Between 2012 and 2015, U.S. companies acquired $1.7tn of their stock, according to Goldman Sachs, counteracting sales by pension funds, foreign investors, and households.
Indeed, excluding corporate buybacks, net U.S. equity flows would have been negative to $1.1tn in that period despite inflows into exchange-traded funds. In other words, the post-crisis recovery would have looked shakier without the backstop of companies themselves.
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The great buyback boom has been driven by executives keen to flatter their earnings-per-share figures – which boost their bonuses – but also by economic uncertainty. Buyback programs offer more flexibility than regular dividends, as investors react poorly to cuts in the latter.
The party has also been encouraged by investors keen on higher returns and fuelled by tumbling borrowing costs. That has allowed companies to sell bonds to finance buybacks even when earnings have been poor or falling. This is part of a global trend towards greater shareholder rewards while investments have stagnated. Chief executives now invest $2 for every $1 given to shareholders as dividends or buybacks, according to Citi. In 1995, they invested $4 per buck returned to owners. U.S. companies are particularly kind to shareholders, and uniquely among large countries, buybacks outpace dividends Web list Posting.
Fewer buybacks would not matter if companies were ditching their shareholder reward programs in favor of dividends. But dividend-per-share growth is set to slow from 9.3 percent in 2015 to 5.5 percent this year. And the S&P 500’s dividend yield is just 2.1 percent, well below the historical average of 3 percent.
Corporate austerity has come as once-towering cash piles have begun to shrink due to falling profitability and recent shareholder generosity. Non-financial companies in the S&P 500 still sit on $825 billion, but America’s 50 wealthiest companies account for most of the nest egg. According to Bloomberg data, the median cash or cash equivalent for all S&P 500 companies shrank to $860m in the second quarter of the year, the lowest in three years.
At the same time, borrowing to boost shareholder payouts becomes less feasible, with many measures of indebtedness now at or near record highs after the post-crisis bond issuance spree. Some analysts say we are seeing a crucial point in buybacks – with negative implications for equity markets buttressed until now by share repurchases.
“Dwindling balance sheet flexibility will become a serious constraint underscoring that the tailwind from buybacks is ending and could [change] into a headwind next year if cash flow does not recover,” BCA warned in a recent note. Nonetheless, this is probably not the beginning of a sharp reversal, just a natural trend of corporate frugality. A buyback slowdown makes sense, given the recent economic softness, the shock of the U.K.’s vote to leave the E.U., the uncertainty caused by the looming U.S. presidential election, and declining profitability.
