Pundits have spoken at length about how so much of the recovery of the financial markets has been based on aspects other than earnings, such as multiple expansion and buybacks. That does not tell the whole story. Since the second quarter of 2009, 69% of the change in the S&P 500 has been due to higher earnings, whereas only 31% of the change has been due to factors like multiple expansion and buybacks.¹
Naturally, this makes people pause and wonder how much of the higher earnings have been spurred by share buybacks, as reducing the share count of a company can bolster earnings per share. Since the second quarter of 2009, only 2.5% of that 69% earnings figure has come from share reduction, meaning a whopping 66.5% of the higher earnings figure is profit growth.²
Let us dive a bit deeper into buybacks, as they are often misconstrued to investors. Back in 2015, many pundits were speaking about buybacks peaking in the market, insinuating that the market would have a difficult time appreciating without the help of companies buying back their own stock. As can be seen below, that has proven to be completely incorrect.
Utilizing nominal numbers can often be quite deceptive, as so much of the market operates in relative figures (overvalued, undervalued, over bought, under bought, etc.). There’s a reason people use ratios when evaluating market opportunities. If everybody based investing on nominal numbers, the market would always be compelling because sales are almost always going up! This is why people use a price-to-sales ratio, for example, so that they can get an understanding of what the market has historically paid for each incremental unit of sales.
Let’s extrapolate this concept to buybacks. We would argue that a fair ratio to glean some information regarding levels of buybacks would be to divide the nominal dollars of buybacks in the S&P 500 by the market capitalization of the S&P 500. That way, we can get an understanding of what percentage companies are buying back of the broad index.
As can be seen below, despite nominal buyback numbers hitting a peak in 2015, as a percentage of the market cap of the S&P 500, the relative amount of buybacks was well below historical peaks.
When looking at this chart, it becomes clear that a much stronger argument that buybacks were propelling the market upwards occurred in 2007, when companies were buying back ~1.25% of their outstanding shares on a quarterly basis. Even as of the fourth quarter of 2015, when buybacks hit a high on a quarterly basis, the percent of the S&P that companies were buying back was well below all-time high numbers. The buyback metric is an important figure to pay attention to, however, simply attempting to glean insight from the nominal amount of buybacks is not sufficient to make any conclusions on the broad market.
¹ Data Source: Bloomberg, Source: Carmel, Urban. “The Fat Pitch.” fat-pitch.blogspot.com
² Data Source: Bloomberg Source: Carmel, Urban. “The Fat Pitch.” fat-pitch.blogspot.com
