Frequent readers will recall that it was Andrew Lapthorne’s revelation back in late 2015, which was behind the following chart, indicating that virtually all net debt issued this century has gone for one thing: to fund buybacks, i.e. wealth transfers from bondholders to shareholders.
Now, in a follow up note as the increasingly politically-charged topic of record (projected) buybacks…
… which over the past few days has once again made the financial media rounds (WSJ: “Record Buybacks Help Steady Wobbly Market“; Barron’s “Why the Buyback Boom Is Bullish for Investors“; ZH: “This Is What The Slow-Motion LBO Of The Stock Market Looks Like“), Lapthorne reminds his readers that “we are anti-buybacks for the simple reason that while the theory is sound, in practice they are hugely inefficient.” And as Lapthorne explained last year, “typically it is the weakest not the strongest businesses that buyback”, which if accurate raises big question markets about some of the most lauded companies in the S&P500:
Lapthorne is also against buybacks because, as he often notes, “there is also a strong tendency to use debt rather than spare cash, which has led to a dangerous build up in US leverage“, and he is right: see the top chart for evidence.
But have buybacks really helped stocks outperform the overall market? As we noted over the weekend, according to WSJ calculations the answer is yes as “of the 20 S&P 500 companies that spent the most on buybacks over the first quarter, nearly three-quarters have outperformed the index so far this year. The group has risen an average of 5.2% in 2018, compared with the S&P 500’s 1.9% gain.” Lapthorne is not so sure, and writes that while “much has been made of the surge in repurchases, which leapt 20%+ in the last quarter as companies took advantage of repatriated cash and tax cuts to increase their buyback programs” a more nuanced look reveals something surprising.
Of course, the S&P500 is up over 20% over the last year so 20%+ is just keeping up with market prices, but newswires are still full of glowing articles proclaiming companies that bought back in Q1 outperformed and have helped prop up the equity market. We find differently. When measured as a % of market capitalisation, businesses that buy back the most of their market cap underperformed – albeit not significantly so.
Wait, but if buybacks did not have a direct impact on outstanding shares, what were they used for? And here another stunning revelation by Lapthorne: “it looks like the bulk of last quarter’s repurchases went on stock options (aka wages).”
We recognise that calculating the stock option effect is an educated guess as we look at the amount repurchased versus the actual reduction in the share count and assume the difference is the option issuance effect (though issuance can be for other reasons).
The SocGen strategist’s conclusion: “looking at the table below it appears as if buybacks have indeed gone to pay higher wages, but we suspect not in the way policymakers hand in mind.”
Well, at least someone is getting rich from Trump tax reform, too bad it’s the opposite of the middle class that was supposed to benefit.