STOCK BUYBACKS – HERE WE GO AGAIN
U.S. firms have been the biggest incremental buyer of stocks in each of the past four years, with their net purchases exceeding $2 trillion - Federal Reserve data on fund flows compiled by Goldman Sachs showed. Critics of stock buybacks have said for years that buybacks are not the proper use of a company’s resources and only enrich the executives in the company. Companies that buy back stock say they are buying what they feel are undervalued shares and are, therefore, doing what is right for their shareholders. TPA would argue that buybacks enrich executives who hold a lot of stock by decreasing the supply versus demand and driving stock prices higher. Buybacks also make the company’s PE’s look better by reducing the denominator in the P/E formula. In this report, TPA will show that, unlike the diatribe from CEOs, companies actually buy back stock when their shares are historically expensive and that as the economic and political climate changes, those stocks that have had the largest buyback programs are beginning to and will continue to underperform.
Companies are scaling back stock buybacks in light of the pandemic. Birinyi Associates, the leading firm that does research on buybacks, shows below that announced buybacks have declined significantly in 2019… “biggest drop to start a year since 2009, according to Birinyi Associates Inc.” (chart 1). This would seem to follow logically, as firms deal with the business downturn that is already affecting the world and will undoubtedly worsen in the weeks and maybe months to come. Chart 2 below shows cash levels falling dramatically and debt levels spike.
While companies have lobbied for government assistance in the wake of Covid-19, there has been a loud yell from lawmakers that companies that get assistance will not be allowed to buyback stocks for the foreseeable future. The New York Times wrote,
“Perhaps no other industry illustrates the awkward position that corporate America finds itself in more than airlines. Major airlines spent $19 billion repurchasing their own shares over the last three years. Now, with the coronavirus virtually paralyzing the global travel industry, these companies are in deep financial trouble and looking to the federal government to bail them out. The Treasury has asked Congress to approve around $50 billion in emergency loans to shore up the airline industry. Delta and United have suspended their buybacks, and airline executives have committed to halting buybacks for the life of the federal loans they might receive.” https://www.nytimes.com/2019/02/25/business/stock-market-buybacks.html
Let’s talk about the argument that companies buy back stock because it is inexpensive. The charts below would not only not back up that argument, but would lead to the opposite conclusion. In the chart below, TPA has overlaid a Bloomberg chart of the S&P500’s price and its EBITDA from 2004 to the present on top of the Goldman Sachs chart of yearly stock buybacks for the same timeframe. Unlike the rational given by corporate executives, companies bought back the most stock when the S&P500 price and EBITDA are at their highs (2006, 2007, 2016, and 2019) and bought back the least amount of stock when the S&P500 prices and EBITDA are low (2004, 2008, 2009, and probably now).
What will happen now?
PKW, the Invesco BuyBack Achievers ETF, tracks a market-cap-weighted index of stock in U.S. firms that repurchased at least 5% of their outstanding shares in the previous 12 months. On average, the stocks of companies that buyback the most have been big outperformers. The first chart below shows the relative performance of PKW and the S&P500 from the low on 3/9/09 to the end of last year (2019). The PKW (buyback stocks) were up 471%, while the S&P500 was up 377%. So far in 2020, however, the S&P500 is down 24%, while the PKW is down much more; 34%. TPA believes there may be some relief rallies, but the pattern of buyback stock underperforming should continue.