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 Just this week, 3M <MMM.N> and Boeing <BA.N> alone authorized as
much as $32 billion in repurchases, jumping on a bandwagon that has
already attracted nearly 500 U.S. companies, including industry
leaders like Microsoft Corp. <MSFT.O>, General Electric Co. <GE.N>
and Wal-Mart Stores Inc. <WMT.N>.
The repurchases, and a related surge in dividend payouts, represent
a victory for shareholder activists and a short-term bonanza for
investors.
But they also trouble some observers.
David Rosenberg, chief economist at Gluskin Sheff, worries the
repurchases are siphoning money away from other more productive
investments that companies should be making at this period in the
business cycle, such as capital goods, technology, acquisitions and
employees.
In the first three quarters of 2013, U.S. companies have invested
$433 billion on machinery, plants and software, according to Howard
Silverblatt, senior index analyst at Standard & Poor's.
While that's up from $416.2 billion they spent on capex in the
comparable period in 2012, it's about half of what they've spent on
buybacks and dividends this year.
The cautious use of cash could come back to haunt U.S. companies — and leave them looking flat-footed — if the economic recovery begins
to gain speed and confidence in 2014.
That's a scenario that looks increasingly likely following Friday's
upward revision of U.S. third-quarter gross domestic product
numbers. The Commerce Department said the U.S. economy grew at a 4.1
percent annual rate in the third quarter, its best showing in almost
two years and up from a previous estimate of 3.6 percent.
Time Warner Cable <TWC.N> provides a timely illustration of the
dangers that come when a company focuses on financial engineering
rather than business development and innovation.
Its stock price has increased more than five-fold and it returned
more than $9 billion to its shareholders in dividends and stock
buybacks, but the nation's second-largest cable operator has become
one of the industry's weakest performers and is seen as a takeover
target.
Rosenberg, who has had a reputation for bearish calls over a decade
but is now optimistic about the U.S., said the current environment
with its flurry of buybacks is "one of the weakest investment cycles
ever", and says that productive investments are a key "missing link"
in the economic recovery.
Data from FactSet supports Rosenberg's take. Capital spending by
non-financial companies in the S&P 500 is expected to rise just 3.8
percent in 2013, according to the financial analytics firm.
Capital spending rates can swing widely from year to year. But this
year's paltry forecast increase in spending on new machines,
facilities and IT is well below the median annual growth rate of
10.5 percent since 2007, according to FactSet.
Then there are the fears the activity could be a warning sign the
high-flying stock market is headed for a correction.
The last time repurchases reached this level was in 2007, according
to Thomson Reuters data, right before the stock market crashed.
"Companies are generally not very good at timing their buybacks,"
says David Santschi, the chief executive officer TrimTabs Investment
Research.
But Santschi says that track record should not come as a surprise.
The purpose of most repurchase programs, he says, is to offset the
effect of insiders dumping their shares while stock prices are high.
"Companies aren't buying back stock because they're great market
timers ... They're not trying to outperform market averages. They're
buying back stock to reduce or eliminate dilution. So they don't buy
as much when stock prices are low."
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RISK AVERSION
So far this year, nearly 500 companies have pledged to buy back
$475.4 billion of their own shares, according to Thomson Reuters
data. That's the second-largest flurry of repurchases ever,
according to Thomson Reuters, and the largest buyback since 2007,
when they bought back $623 billion in shares.
America's biggest companies are also on track to pay out another
$310 billion in dividends — an all-time record, according to Howard
Silverblatt, senior index analyst at Standard & Poor's.
The moves have helped fuel a rally on Wall Street and, by reducing
the number of shares outstanding, are lifting the reported
earnings-per-share of the companies making the repurchases.
But some experts question whether those payouts, especially the
buyback authorizations, really represent the best use of corporate
cash — especially when many shares are near record levels.
"It is always odd to see buybacks picking up when the market is at
all-time highs," said Paul Hickey, co-founder of Bespoke Investment
Group.
"After all, if the insiders are so plugged in to their companies,
wouldn't they buy when prices are low?"
BENEFICIARIES OF BUYBACKS
Ordinary shareholders are benefiting from the repurchases, for sure.
But so too are corporate executives whose compensation is tied to an
earnings per share metric. By reducing the number of shares in
circulation, buybacks have the effect of making reported EPS rise — even if profits are stagnant.
The buyback boom could also help executives by creating favorable
conditions for them to sell shares they receive as part of their
compensation. And in fact, "insider sales" have been on the rise
lately.
TrimTabs says that based on its analysis of Form 4 filings with the
Securities and Exchange Commission, insiders sold $7 billion of
their holdings in November. That was the highest level of insider
sales seen since May and a 40 percent jump over the five-year
average of $5 billion a month.
Who else benefits from buybacks and the stock rallies they help
fuel? Short-term investors, who are playing a big role in the
current rally on Wall Street.
Jack Ablin, the chief investment officer at BMO Private Bank in
Chicago, points out that margin debt — a gauge of the level of
speculative activity in the stock market — is at an all-time high,
surpassing the 2000 and 2007 peaks and that such peaks have
"historically corresponded to stock market peaks."
(Editing by Christian Plumb and Chizu
Nomiyama)
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