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Record stock buybacks are likely to continue

Record stock buybacks are likely to continue

The stock market bottomed for the year on Feb. 11, with a nifty 15% uptick in the S&P 500 index since then. Investors have credited more stable markets in China, a genial Federal Reserve that has delayed planned interest rate hikes, and resilient consumer spending.

Another factor has been at work, however: Stock buybacks, which hit a new record high during the last 12 months, according to the latest numbers from S&P Dow Jones Indices. For the last four quarters, ending in March, big companies spent $589.4 billion buying back their own stock, the most ever for any 12-month period. Buybacks in the first quarter of 2016 alone totaled $161.4 billion, the second-highest quarterly total since 2007, when the market peaked right before a punishing recession began. Increased demand for stocks created by buybacks would explain at least some of the buying action that helped stocks recover after Feb. 11.

The five companies executing the largest stock buybacks in the first quarter were Gilead Sciences (GILD), Apple (AAPL), General Electric (GE), Pfizer (PFE) and McDonald’s (MCD). Many buybacks are spurred by shareholders demanding better returns, especially in a market that’s been going sideways for the last year.

Companies can afford the buying spree. S&P 500 firms now have $1.3 trillion in cash on their books, also a new record high. Since the average return on cash is around 1.3% annualized, companies may feel their money is well spent buying back shares.

Buybacks typically push stock prices up because they reduce the supply of a company’s shares available to the public, meaning the price must rise if demand remains constant. The maneuver also makes earnings look better, since earnings-per-share, a common measure of company performance, goes up by definition if there are fewer shares to divide earnings by. Savvy investors watch out for such sleight of hand, but stock buyers in general may be more willing to own shares in a company comfortable with buybacks than in a firm averse to them.

Still, buybacks are controversial for a few reasons. For one, they push stock prices up in a way some investors consider detached from the real economy, since price increases are based on a smaller supply of shares rather than enhanced revenue or profitability. So they might create the impression the underlying economy is improving, when in fact, a company is pushing its own shares higher somewhat artificially.

Second, buybacks divert capital that companies could spend on investments in the real economy that create jobs and contribute to economic growth, such as purchasing new equipment or opening new facilities. CEOs, however, often point out that they would spend money on those things if demand justified it. Instead, they’re waiting for demand to improve and trying to appease shareholders in the meanwhile.

The buyback binge shows no signs of slowing. “Companies have more cash than ever, so they have the ability to do this,” says Howard Silverblatt of S&P. “This is not going away. This is growing.” That outlook might change if corporate cash flow begins to get pinched, which would be apparent as companies drew down that record pile of cash sitting on the sidelines. If the Federal Reserve ever gets around to raising interest rates in earnest, that could eventually crimp buybacks as well, because higher rates would produce a better return on corporate cash. For now, however, investors may want to enjoy positive returns no matter where they come from.

Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.

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