Saturday, June 07, 2008

Buyback Mania by the Numbers

The following chart graphs the quarterly earnings, dividend payments, and stock buybacks of the S&P 500 companies from 1999 through today. (The data is from the Standard & Poor's website)

The first obvious feature on the chart is that the total of stock repurchases and dividend payouts began an explosive growth phase in the middle of 2003, starting from a low of $65 billion in 2Q 2003 and reaching a high of $231 billion in 3Q of 2007. Most of that growth was in the buybacks, which rocketed from $28 billion to $171 billion - an increase of 510% in 4 years. At the peak, corporate stock repurchases accounted for approximately 5% of all stock purchases. It doesn't take a rocket scientist to realize that the added demand for stocks due to these buybacks contributed to the bull market of 2003-2007.

The most disturbing feature of this trend is that the surplus earnings - left over after dividend and buyback payouts - shrank to almost nothing in 2006 and turned negative in 2007. (Notice that the brief shortfalls in 2001 and 2002 were more than made up for by surplus earnings pre-2001 and in 2003 and 2004.) The projected earnings in 2008 and 2009 don't improve this picture, as they fall about $80 billion per quarter short of the most recent dividend+buyback peak. This means that corporations will have to borrow hundreds of billions of dollars to maintain the pace of repurchases, or else they will have to drastically reduce the buybacks. The former solution would create a long-term debt burden which would hurt corporate profits, while the latter would have an immediate negative impact on stock prices, since buybacks have accounted for a significant fraction of the price-sustaining buying pressure over the last several years.

The bottom line is that the buyback mania cannot be sustained. This has bearish implications for the stock market because it means that buying pressure will eventually be reduced in the coming years. This has little to do with the economy - it follows from the simple math of a buyback trend that has outpaced earnings. It would eventually happen with or without a recession, but the current economic slowdown will probably hasten the end.

4 comments:

Keith Wilson said...

Once again, your analysis of pure statistics and facts is truly amazing.
Somehow you are able to assemble an assortment of graphs and charts, analyze them, then make sense out of it for those of us who wouldn't even know where to begin.

Wow, what a great analysis of a very confusing market. You always find and see things that no one else seems able to do.
KDW

Neil said...

Jody,

Glad to see some new posts today! I always enjoy your insight and analysis, as I know of no one else who's talking about these kinds of trends in the market today.

Some questions - what ever happened to your MF CAPS profile? I added you as a friend on there, but noticed that you seem to have been inactive a while and that your score has tanked. Hope you return!

And now, related to your post, a question about overall demand for stocks. I believe you stated that at its height, corporate buybacks accounted for 5% of all demand... this would mean that institutions and individuals would account for the other 95% of demand, is that correct? I can understand your argument about buybacks being unsustainable, but doubt that a missing 5% demand (should all corporations decide to stop buying back) would have a large impact on the overall market. I am curious if I understood this right, and your thoughts.

Also, I thought it might be worth mentioning that I'm an optimist / Fisher-style snorting bull on the market and economy, especially long-term. Cheers, and keep up the analysis!

-Neil

Jody said...

Thanks Neil,

I've stopped making my medium-term trades in CAPs for two reasons:
(1) It takes a LONG time to buy and sell 150 ETFs in CAPs.
(2) It's not really worth it any more since my oversight in December caused my accuracy to plummet from 90%.

All my CAPs picks today reflect my long-term bearish forecast, and I won't cash out of those until I think the market has hit bottom. If my score is a little more respectable at that point, then I'll resume my blogging there.

Regarding buyback demand and share prices; every little bit of supply and demand makes a difference. The direction of the market on any given day comes down to one thing: are there more buyers or sellers at the table? When there are more buyers, prices go up until balance is achieved, and vice-versa. The same thing is true over longer stretches: bull markets indicate excess buyers of stocks, while bear markets indicate excess sellers.

A long-term addition of 5% to the buyer population will have a significant effect. On days when the ratio would have otherwise been a bearish 95 buyers-to-100 sellers, the excess 5% will make for a flat day. On days when the ratio would have been a flat 1-for-1, the excess 5% will tip the balance to the buyer side, causing the market to rise.

Remember, day traders account for a significant fraction of volume, and their long-term effect on supply and demand is a wash, since they buy today only to sell tomorrow. So the real question then is what percent of long-term buys were buybacks? I guarantee you it was much more than 5%.

I too am long-term bullish on the market and the economy, provided "long-term" means ten years or more! :) My bearish forecast right now is not a capitulation on American capitalism. I simply note that there have been occasional massive bear markets with economic slowdowns in the past, and accept that they will continue occur now and then in an otherwise long-term upward trend.

Neil said...

Jody,

Thanks a lot for expanding on that - I get what you're saying now and see its merit.

I am now wondering what incentive there is for corporations to buy back stock. I'm also trying to think about future long-term buying and selling populations for equities - ie, will baby boomers cashing out have a significant effect on the market? Or what about the rising middle class in developing countries? I'm not sure if you care to address any of that here or perhaps in a separate blog post, but your thoughts are always welcomed and appreciated.

A very interesting and complex world we live in!

Oh, and don't stress about the CAPS too much - I believe the best stock gurus hover around 70%-80% accuracy over the long haul. I went from being in the bottom 20% of players to the top 20% (and have been everywhere since) over the course of a few months based on where my accuracy and picks lie on any given day. My hope is to eventually be able to pick 'em like the top players, but I am only 8 months new to the market.

Anyway, thanks again for the response and great blog!

-Neil