Stock buybacks among large U.S. multinationals are poised to reach their highest level since the recession once third-quarter results are done, as companies step up repurchases to take advantage of lower stock prices.
The increase, however, raises several questions for investors because buybacks can make earnings look more robust than they really are, and because more money spent on shares means less invested in the business.
Even institutional investors may not fully appreciate the effect buybacks have on earnings, said Howard Silverblatt, senior index analyst at Standard & Poor's.
Companies are going to spend what they need to do to protect earnings. he said.
Buybacks among S&P 500 companies slumped from 2007 to 2008, when the United States entered a recession, and bottomed in the second quarter of 2009. They have risen steadily since then, notching up eight consecutive quarters of sequential gains, according to S&P, which says the third-quarter total may top the second-quarter's $109 billion.
In the second quarter, the most recent for which S&P provided data, buybacks accounted for just under 1 percent of the S&P 500's total market capitalization. At their decade peak, in third quarter 2007, buybacks accounted for 1.3 percent of the S&P 500's market cap.
The majority of U.S. companies that have reported third-quarter results so far have beaten Wall Street forecasts, many by just a penny or two per share. Pressure to make the number is no less intense when the economy is lousy.
Buying back stock when prices are low can be smart, but the scale of recent buybacks raises questions about the quality of earnings beats, analysts and investors said. Buying stock may foster shorter-term thinking in the management suite as executives use cash, or raise debt, to buy equity when the business may need additional investment.
Investors are not sensitive enough to know easily how a company can tack on a couple of cents to their earnings-per-share by lowering the share count, said Kevin Beech, manager of equity analysis at Behind the Numbers, a research provider.
If management has done a deep dive and feels it's the best use of funds, that's one thing, Beech said. But companies from time to time use, not chicanery necessarily, but accounting help and Band-Aids, to hit their numbers.
Through the third quarter, U.S. companies authorized more than $400 billion in stock repurchases, up by nearly half over 2010's year-to-date total, according to Birinyi Associates.
They include Lowe's
Buybacks rose steadily in August then flattened, but last week reached a 13-week high of $16.4 billion, averaging $3.3 billion a day. Some jumped too soon as weekly buybacks peaked in late April, when the S&P 500 index <.SPX> was near highs for the year.
For a graphic, see http://link.reuters.com/wuz64s
APPETITE FOR STOCK
In 2004 and 2005, investors rewarded companies that reduced share count, so buybacks soared, but by 2008 nervous companies reduced or stopped such programs, Silverblatt said. These days, companies are negating stock options or shares used for acquisitions, but are not yet broadly reducing share counts.
Companies are not making that leap yet, he said. The question is, is the trend starting? Is Occupy Buyback starting up again? If we get more certainty and less uncertainty, yes.
Some buybacks are more effective than others. Netflix
If the current pace continues, EPS could get a sizable boost next earnings season, said Trim Tabs, which analyzes stock market liquidity.
Some companies may be playing a quarter-by-quarter earnings game, but that is hard to prove, said Leon Mirochnik, research analyst and associate portfolio manager at Trim Tabs.
Long-term, I don't think it's in their interest, he said. It's not a sustainable measure of earnings power.
The recent increase in buybacks reflects a lack of confidence in the economy, so companies' own shares look like a better bet than other investments, Mirochnik said.
At the moment, I think they're doing the right thing from a capital structure perspective, he said.
Mirochnik added, however, that corporate insiders are selling more than they are buying, even as their companies spend big. When executives and companies are both buying, that combination is a strong predictor of future stock gains, but that is not happening now.
PRESSURE TO MAKE THE NUMBERS
Buybacks can substantially lift reported results.
Earnings per share grew faster than net income due to share repurchases, Chief Financial Officer James Sawyer said.
Rival Airgas Inc's
When Dr Pepper Snapple Group Inc
Illinois Tool Works
That discount made it pretty attractive for them to do that, and it also highlights potentially some challenges in the market to meet their guidance, said Jeff Windau, industrials analyst at Edward Jones.
(Additional reporting by Martinne Geller, Krishna Das, Lewis Krauskopf, David Gaffen, Ernest Scheyder and Sinead Carew in New York, John Stoll in Detroit, Scott Malone in Boston; Editing by Bernard Orr)