A significant number of companies on the U.S. stock market continue to “engineer” their corporate earnings with stock buyback programs. Sadly, investors have become too complacent with this and remain overly optimistic. Beware! This is dangerous.
Earnings Now Outright Misleading at Very Best
I know I am one of the only few talking about it; companies on the key stock indices are showing better earnings per share due to share buybacks (or cost cutting), but not sales growth. I started writing about this a couple of years ago now and I see the disturbing trend continuing with investors really not caring about this engineering of public company earnings.
If you look closely, you will notice that the organic growth of most S&P 500 companies is next to nothing.
Take the giant food and beverage company PepsiCo, Inc. (NYSE/PEP), for example. On July 9, it reported its financial results for the second quarter of 2015 where its earnings per share increased by three percent. (Source: PepsiCo, Inc., July 9, 2015.) What did the stock price do after earnings? It jumped.
Looking closer at the results; PepsiCo’s net sales declined six percent year-over-year. Corporate earnings were slightly higher, by 0.1%, mainly due to cost reductions. In other words, there was no organic growth.
Here’s the kicker; PepsiCo’s outstanding shares declined by 2.6%. Notice how similar it was to the increase in earnings per share of three percent.
I don’t mean to single out PepsiCo. This sort of behavior prevails across the board in corporate America these days. Like they say; you can fool some of the people some of the time, but you can’t fool all the people all the time. This corporate earnings engineering trick will not end well. Instead of choosing to invest their cash (and borrowings) into expanding their businesses, executives are using the money to buy their own companies’ shares; a huge mistake in the long term.
Watch Out; Gruesome Earnings Expectations Ahead
Despite the billions of dollars public companies are spending on stock buyback programs; it won’t help their earnings this quarter.
For the second quarter of 2015, corporate earnings of the S&P 500 companies are expected to decline by 4.5% year-over-year, the most since 2009!
Where’s the Stock Market Headed Next?
In the first half of 2015, key stock indices like the Dow Jones Industrial Average were flat, if not down. That’s the worst first-six-months-of-the-year performance in years. Just look at the chart below. Stocks have gone nowhere in 2015. Does this mean the jig is up? Sure looks like it.
Chart Courtesy of www.StockCharts.com
The longer stock indices remain flat, the more investors will start to question why key stock indices aren’t moving higher. This will lead them to pay more attention to the fundamentals. And that’s when panic selling could come in.