What the share buyback frenzy is telling us

US firms are buying their own shares in record numbers, but there are potential long-term costs.

US firms are buying their own shares in record numbers. Last year, S&P 500 companies authorised $679.5bn of buybacks, a record annual figure. Already, 2015's strong start puts it on track to beat that. Like paying dividends, buybacks are seen as a way to return cash to shareholders. Reducing the shares in issue boosts earnings per share (EPS) and, in theory, drives up the share price.

But there are potential long-term costs. Using "spare" cash for share buybacks, rather than investing in new growth, suggests that a company has run out of ideas for creating long-term value. Also, executive compensation often depends on hitting earnings per share (EPS) targets this makes buybacks an easy way to juice their pay, even if there's no sensible business rationale for doing it.

And with interest rates at rock bottom, many firms are borrowing money to buy back shares undermining their balance sheets in order to push up EPS. "You're basically robbing your future [through underinvestment], and you're going to have a lower growth rate because of all this debt," says Mark McComsey of BHWM Asset Management.

Also, adds Avi Salzman in Barron's, history shows that companies have "terrible" market timing. It makes no more sense for a company to buy its own shares at high valuations than it does for any other investor to do so yet they tend to "buy high". For example, they spent 34% of their cash on buybacks in 2007, as the market topped, yet only 13% in 2009, when it bottomed. Goldman Sachs reckons they will spend 28% this year.

Recommended

The world’s fund managers are getting very bullish – be careful out there
Stockmarkets

The world’s fund managers are getting very bullish – be careful out there

The latest survey of fund managers shows them to be extremely bullish on all the same things. And that, says John Stepek, means the market is in dange…
21 Jan 2021
Inflation looks likely to take off this year – but there’s one key risk
Inflation

Inflation looks likely to take off this year – but there’s one key risk

With the world’s governments spending money hand over fist, inflation looks certain to take off at some point. But China could change all that. John S…
19 Jan 2021
Five online retail stocks to diversify your portfolio with
Share tips

Five online retail stocks to diversify your portfolio with

Professional investor Tancredi Cordero, founder and CEO of Kuros Associates, selects five of his favourite online retail stocks to buy now.
18 Jan 2021
Why investment forecasting is futile
Investment gurus

Why investment forecasting is futile

Every year events prove that forecasting is futile and 2020 was no exception, says Bill Miller, chairman and chief investment officer of Miller Value …
18 Jan 2021

Most Popular

Why we won’t see a house-price crash in 2021
House prices

Why we won’t see a house-price crash in 2021

Lockdown sent house prices berserk as cooped up home-workers fled for bigger properties in the country. And while they won’t rise quite as much this y…
18 Jan 2021
Prepare for the end of the epic bubble in US stocks
US stockmarkets

Prepare for the end of the epic bubble in US stocks

US stocks are as expensive as they’ve ever been. How can you prepare your portfolio for a bubble bursting?
18 Jan 2021
The best investment trusts to buy for 2021
Investment trusts

The best investment trusts to buy for 2021

Sectors ranging from emerging markets to student accommodation look poised to do well this year, says David Stevenson, as he picks the best investment…
19 Jan 2021