Executives are spending billions buying back their own stock, but their efforts are slowing, destroying the American economy.
A new report from Aranca Investment Research concludes that almost $2.3 trillion has been spent on buybacks since 2009, as corporate cash reserves have grown and borrowing costs have declined. More incredibly, over $1.0 trillion will be spent on corporate buybacks by S&P 500 companies in 2015, marking the fifth straight year of increases. (Source: The Wall Street Journal, last accessed August 21, 2015.)
But while analysts on Wall Street are likely cheering the announcement, this isn’t necessarily a good thing for the U.S. economy. The fact is; buybacks are rising and setting new records every year is an alarming indicator because they are financially inefficient, adding little to the actual economy.
They have the effect of raising earnings per share (EPS), as they reduce the overall number of shares on the market and raise the individual dividend payments received by shareholders.
This is where paper value meets real value, and things get tricky. Increasing EPS doesn’t necessarily increase underlying fundamental value in any way. The company had to reduce its cash reserves in order to execute the buyback, which in turn causes investors to reevaluate the company’s total value due to shifts in both shares and total cash.
Translation: you can’t create paper-based value out of nothing and call it growth. But there are other issues. Company management tends to earn the majority of its compensation in the form of stock options, which results in buybacks being an attractive way for executives to absorb excess shares and maximize their own earnings.
Even worse is the temptation for these executives to turn to financing in order to fund buybacks. If a company were to believe it can maintain growing cash flow and service such a debt, its executives might be hard-pressed to avoid such a temptation.
The bottom line is that buybacks simply have too many drawbacks. The rise in corporate buybacks may be driving the stock market, but it’s also a sign of America’s slow-motion economic collapse. Companies in the S&P 500 are content to sit back and let the Federal Reserve print more money and keep inflating the stock market with imaginary growth.
We’re facing a slowing global economy, particularly in terms of limping demand. And buyback programs aren’t going to cut it. By giving EPS a temporary lift, share buybacks can soften the blow of poor financial performance or declining profits, but they can’t reverse things when a company is in trouble.
The record high in terms of corporate buybacks is a sign of desperation, not growth.