Ever since the financial crisis, corporations have been buying back trillions of dollars worth of their stock.
In doing so, a popular narrative developed: the bull market is the product of financial engineering. And there’s some merit to this argument. When companies reduce share count — all things being equal — shareholder value is created because the same profits are distributed among fewer shares. Furthermore, by buying stock in such mass quantities, companies directly put upward pressure on stock prices.
However, Deutsche Bank’s Torsten Slok and David Bianco believe it’s a mistake to attribute the bulk of the market's gains to buybacks.
“Since March 2009 the market capitalization of the S&P500 (^GSPC) is up around $10 trillion and the total amount of buybacks over the same period is around $2 trillion,” Slok said on Monday. “In other words, the vast majority of the increase in the S&P500 has nothing to do with buybacks.”
“Similarly, the second chart shows that buybacks as a percentage of total market cap has been around 2% per quarter for the past five years, and this is over a period when the S&P500 tripled (from 666 to 2020 today), again suggesting that there is not much evidence that buybacks have played any significant role in this rally,” Slok continued.
“The final observation is that if buybacks are really so powerful in boosting the stock market, why has the stock market basically been moving sideways over the past year, because in 2015 buybacks was at cyclical highs?”
There’s been quite a bit of misinformation out there about buybacks, and it’s largely the result of exaggerations and hyperbole. Two more myths: 1) buybacks are being fueled by cheap debt, and 2) companies spend more cash on buybacks than anything else.
While it’s prudent to be mindful about the impact of buybacks, it’s similarly important to understand its scope and scale.
“The bottom line is that the rally in the stock market since 2009 is real because it has been driven by earnings and not by buybacks,” Slok said.
Sam Ro is managing editor at Yahoo Finance.