I’m working on the third and final part of the Cult of the Bear, and I was looking for research I thought I posted some time ago. Turns out not.
This is a fascinating discussion of where about a third of the SPX earnings growth is actually coming from:
"ONE OF THE BIG arguing points of the bulls is the extraordinary strength in corporate earnings. And, no question, we’ve had a spectacular boom in profits. In the third quarter of 2005, to illustrate, operating profits of the S&P 500 were up a neat 11.5%, the 14th quarter in a row of double-digit gains.
However, as the indefatigable David Rosenberg of Merrill Lynch points out, such a splendid performance reflects not so much any inordinate growth of revenues as the impact of an unprecedented mass of buybacks — $456 billion worth of stock repurchases that TrimTabs Investment Research estimated took place last year.
Operating earnings in dollar terms — as against per-share net — actually were up only 7.8% over the comparable year-earlier total. Which, David notes, was the narrowest gain in three years.
The bottom line: there’s a good deal less to the corporate bottom line than meets eye.
This is yet another example of how the headline data can be misleading versus what lies beneath.And that’s before you figure in the disproportionate impact of the energy complex to the SPX year over year gains.
As we have pointed out before, it is somehow, okay to count great energy earnings caused by oil price increases — but not inflation caused by oil price increases. Hmmmm.
The earnings story is far less robust than many are making it out to be.
Hold the Bubbly
UP AND DOWN WALL STREET
Barron’s MONDAY, JANUARY 2, 2006
Would companies buy back shares if they shares were massively overpriced? Who is in the best position, information-wise, to know if a share is overpriced?
Lemme ask Nate a question: Didn’t companies buy a ton of shares back in 2000?
I just read an article about how pissed Nardelli is that after all the buybacks at Home depot the stock has not budged. Gee, it worked for his old boss.
Same with IBM, billions in buybacks and the stock is still in the low 80s. It seems Palmisano should be cut loose. When they run out of units to sell and the pension fund is empty, they will have no earnings.
Buybacks are one of those urban myths. CEOs don’t have any kind of great insight into future economy or equity performance. Just like mergers and acquisitions. In fact, they are human too and many tend to be the most exhuberant near the top if anything. Although historically, there isn’t alot of correlation to be drawn on either side as I’ve seen it.
Here’s the $64 question I have. If the economy is so good and there is so much global opportunity, why aren’t CEOs spending all of that cash on capex? Why are they looking around and seeing nothing better but than to buy stock? I think they are just like the individual investor. Hesistant. Does that hesitancy create a self fulfilling slow down now that the consumer is likely to spend less?
Funny how this move has been missing the transports and the banks. Neither index has made a new high in this entire run. In fact for the transports, to the contrary. Yet the pigs are out in force. They are more glutenous than at any time in 2005 by my measure. Nearly as glutenous as every major top. Give them a few more swillings and they’ll be ready for the slaughter. And then, there are those good ole futures traders. We are near a meaningful top. The only question is how meaningful. A quick correction? Months? Big? Small?
“Lemme ask Nate a question: Didn’t companies buy a ton of shares back in 2000?”
i am not sure.
counter-question: were a lot of companies using stock to buy companies around the year 2000?
not sure if I will have time, but i may do an analysis on share buybacks and publish it later today or tomorrow at my blog.
Stock buybacks are possibly more *flexible* than cash dividends. A company (ceo or cfo or officers) can buy back shares one year and not the next. Buybacks do not set an expectation with shareholders of recurrent cashflows to shareholders on an annual basis.
It may be that an annual cash dividend, once raised, can not be easily be reduced without punishment in the market.
So stock buybacks may be a flexible way to send cash back to shareholders. Not sure.
You make interesting points in this blog posting.
I thought the reason for buybacks was to enhance the value of their stock options. I am sure many are disheartened by the lackluster response.
I dont think its possible to be cynical enough when it comes to stock buybacks in the age of executive stock options. Wasting a companies cash holdings in an attempt to drive the market price of the shares higher to trigger better payouts on their stock options is not great management. Even worse was what companies like Dell did – management grants themselves loads of options and then spends all the companies earnings buying shares in th market to stop dilution. Net effect is company had a great quarter, but shareholders equity doesnt go up, all that happens is a subtle shift of corporate ownership to the directors/management. Scandalous but legal.
Nate – if management are inept and dont know what to do with the companies money then they can always do a special dividend.
I would like to know the answer to these questions:
1. What are current S&P and Nasdaq P/E’s if you take into account the expensing of options?
2. How much net equity (and cash) does corp balance sheet have, if you put future underfunded pension and health care cost on the balance sheet.
I bet people buying the mkt now are not getting a bargain! (trailing s&p p/e is 20 before looking at question 1 and 2)
I think Nate’s analysis of buybacks as slightly more-flexible dividends is correct. Bowles’s critique of options grants is spot-on, but once you expense those correctly, you should be able both to get some real earnings growth numbers and an indication of just how much cash the market is passing back to shareholders.
Worth noting — it’s a lot. The nominal dividend yield of the S&P 500 was 1.86% at year-end. Those $450B in estimated buybacks add almost exactly 4% on top of that. A near-6% yield is nothing at which to sniff, although only a third of that is in cash.
So, how bad is the options game these days? Happily, I can report that it is not as rapacious as it was. See http://www2.standardandpoors.com/spf/pdf/index/112105_500Impact.pdf
S&P’s estimate is that options expensed for FY05 are less than 7% of reported earnings, driving PEs up by around a point. Compared to FY01-2, when they chewed up 20% of earnings and drove PEs up 10 points, that seems an improvement.
Do you think the “unprecedented” level of stealth dividends continues? Not I, but 4% on top of the 2% cash dividend looks awfully rich in a 4%-treasury world.
To even the score, it would be very interesting to know what are Earnings ex-energy.
“Here’s the $64 question I have. If the economy is so good and there is so much global opportunity, why aren’t CEOs spending all of that cash on capex? Why are they looking around and seeing nothing better but than to buy stock?”
This reminds me. A few months ago I wondered why share buybacks are seens as a boost to share prices. After all, there are less shares available, but the company has just spent a large sum on buying back shares instead of investing and thus increasing future revenue or profit growth.
Thus one share gets you a larger share of any future profit, but that future profit is also smaller.
My conclusion was that this can only seen as profitable for shareholders if they think that the company can’t expand its business much and investors think they could do better with that money than the company.
That’s not exactly a vote of confidence in my opinion.
Still, massive buyback should drive a share”s price up. When it doesnt, it is because the market thinks the share is overpriced. In the long term the truth will be revealed, and who was wrong – the management or the market. Now, there is a problem with long terms …
I never liked share buybacks, and still don’t. I think the managers buy back shares mostly for the following reasons:
· To offset the dilution caused by their own stock options
· To sustain or increase the market price of the shares so that their options end up in the money
· To increase the EPS without doing anything to actually improve their business
· To send a “signal” to the Wall Street Finest (thank you Mr. Matthews!) that “better times” are ahead
· Oh yes, they believe the shares are “undervalued”, at which point we’re supposed to trust their investing judgment
Am I the only one who finds the above reasons unconvincing? If the managers have excess cash on hand they don’t know what to do with they should give it back to the owners (a.k.a. shareholders) and let them decide if they find the shares attractive at the current market price. In other words, pay a dividend.
I concur. You have the right reasons in the right order. Buybacks are largely to stem earnings dilutions from options flooding the market. They only stop the value from falling, not increase it.
See this commentary regarding buybacks and options dilution for more info:
Stock Buybacks – A Red Flag?
As we move from one year into the next, it is a good time to step back and reflect on patterns emerging in various areas of the business landscape. One pattern that I find disturbing is the growth of stock