It takes 50,000 nuts to put a car together, but only one to scatter them all over the road. - Darryl Somers

We have habitually stated that many companies were and still are using share buyback programs to manipulate earnings, by reducing the float of outstanding shares.  This gambit was not as prevalent before, but today it’s gaining traction at a rather astounding pace. Companies borrow money in contrast to using the cash they already have on hand, to repurchase their own shares; this modern form of alchemy turn's losses into profits or can be utilized to make moderate profits appear to be spectacular in nature. This gives this bull market another bullock’s reason to trend higher; yes, we are in the midst of what appears to be a correction, but the market is trading at a lofty level in comparison to 2011. This is roughly the time frame when this activity started to gain steam.  

We are now in the paradigm of lies and deceit.  In these conditions, the truth does not thrive. How can truth or reality have a chance under such conditions? Every piece of data that can be manipulated has been or is being manipulated to create the impression that all is well.

Many experts predict that share buybacks and dividend payments by US companies are expected to reach new highs in 2015.  The troubling factor is that it appears that companies are taking the easy path in their quest to boost profits. Rather than investing in the future, they are spending inordinate sums of money on buying back their own shares.

Goldman Sachs forecasts an 18% jump in buybacks for 2015. David Kostin, chief U.S. equity strategist at Goldman, stated the following in a note to clients. 

"Corporate activity in early 2015 supports our view that the S&P 500 will return more than $1 trillion of cash to investors this year,"

The Fed’s balance sheet has swelled to roughly $2.4 trillion since the start of QE. S&P 500 companies have spent $2.41 trillion on buying back their own shares since the beginning of this bull market. Thus, it would be fair to state that US corporations have taken over from where the Fed left off. 

What could be construed as alarming is that in the first quarter S&P 500 companies returned more money to shareholders than they earned. This occurred in the 4^th quarter of 2008, when the entire S&P 500 reported a net loss but still forked out over $110 billion on dividend and share buybacks.  Something is off here, and based on Howard Silverblatt comments (a senior index analyst at the S&P Dow Jones indices) it would seem that he concurs.

“It’s the addiction now,” Silverblatt said. “We’re trading in one for another.”

Silverblatt said about 12% of companies in the S&P 500 are already on track to reduce shares by about 4% or more, compared with the second quarter a year ago. He expects that to grow to about a fifth of the S&P 500 when all the numbers are in. That provides a significant tailwind to earnings per share, or EPS

Last year, corporations deployed approximately $540 billion to purchase their own shares. Other experts state the number is closer to $700 billion. Whichever, figure is used the numbers are huge.   Why would they do what could be construed as foolhardy behavior?  Money is cheap, and executive compensations are tied to share performance. As we are in the age of lies and deception, the method employed is irrelevant; as long as the end justifies the means, ethics be damned.  Whatever false truth has to be told is told in order to give the impression all is well.

1. Last year was a massive year for share buybacks; as we stated $540 billion was used for this purpose.
2. $141 billion in buybacks were authorized in April of this year setting yet another record
3.  For 2015, so far, over $400 billion has already been earmarked for share buybacks. One can only imagine how much will be spent by year’s end.
4. From 2001, only the companies in the S&P 500 have spent over $3.1 trillion on buybacks.
5. Over the past decade companies that make-up, the S&P 500 have spent over 54% of profits on share buybacks.

In days gone by, a large percentage of earnings found their way back into the economy via higher wages and increased investments in plants and equipment. No longer, these buybacks drain trillions of dollars out of the economy and inflate share prices while producing nothing of value.  Corporate executives have always been under pressure to increase EPS; once the only option was to actually do something by improving earnings via selling more products or services, today they can simply increase the EPS by reducing the number of outstanding shares; it’s modern alchemy at its best.

James Montier challenges the fixation with “shareholders value maximization”  in  a paper titled “The World’s Dumbest Idea,”. He goes on to illustrate how this obsession with stock buybacks and dividends has actually reduced business investment; Montier states that shareholders are not providing capital to corporations but are instead extracting it. He goes on to show that since 1980, public companies have repurchased more equity than they have issued.

How did we get to this stage? Prior to regulations being loosened in 1982 by John Shad, corporate executives avoided share buybacks because they were afraid of being prosecuted. The change in rules and the shift towards stock-based compensation for executives changed the financial landscape forever.  For those of you looking for more details, this article does a pretty good job of that.

The situation is so pervasive now, that experts estimate over 25% of S&P 500 have used this strategy to inflate their earnings and this indirectly inflates share prices, which gives them even more impetus to perform the same dirty deeds repeatedly. These shenanigans are not restricted to small players; big companies such as Apple (AAPL) are also using this trick. Soon every company that has access to easy money will employ this tactic. Hey, why spend time trying to improve business, if you can just borrow the money and give the impression that business is booming, even though profitability might actually be declining.

 In 2012, the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets. Profits Without Prosperity (Harvard Business Review

Conclusion

When compensation is based on share performance, then individuals will take the easy way out as the sums of money involved are huge. The era of cheap money only adds gasoline to an already raging fire. For the time being, the average Joe does not have access to this cheap money. Towards the end of the game, a path will miraculously open that allows the average Joe to take on large amounts of debt; this is what led to the housing bubble. . After all, someone has to buy all this crap at an inflated price right. The feds officially stopped QE, but the corporate world has taken over where the Feds left off, and this is all due to the easy money the Fed is providing them. So forever, QE is still going on. This also explains why share prices continue to trend higher despite an economy that has a pathetic growth rate. Against this backdrop of wonderful growth (us being sarcastic), share prices have doubled over the past five years and so has corporate debt. Coincide, we think not.

We anticipate corporate debt to ascend to levels that might make the current levels appear to be sane in comparison. History repeats itself for the masses elect fools into positions of power with the expectations that the outcome will be lovely, when things fall apart, they are shocked and wonder why. Perhaps they should hit an injured toe with a hammer instead of applying a bandage, and then marvel at why it hurts ten times more. 

It is a fraud to borrow what we are unable to pay. - Publilius Syrus