Share buybacks are among the more controversial practices in corporate America. It falls under the stigmatized category of “financial engineering.” And since the financial crisis, companies have spent trillions buying back stock.
While the bulk of these buybacks have been financed with cash flows from operations, interest rates have been so low that companies have been incentivized to actually borrow money to buy back stock. In fact, recent data show buybacks are increasingly being financed by debt.
“S&P 500 (^GSPC) companies have announced 141 new buyback programs YTD with an aggregate dollar value of $327 billion,” JP Morgan’s Dubravko Lakos-Bujas observed. “39% of repurchases YTD were funded by issuing new debt versus 22% in 2015.”
It’s worth reiterating that the bulk of buybacks are financed with cash.
“While this portion is the highest since the Dotcom bubble, the majority of stock buybacks still remain funded with internally generated funds rather than debt,” Lakos-Bujas said, further noting that net debt as percentage of total assets is near record lows.
Why companies buy back so much stock
These stock repurchase programs have been an incredibly popular way to spend cash for two reasons: limited growth opportunities and low interest rates. Because economic growth has been somewhere between flat to lackluster, companies have been unwilling to invest capital into growth initiatives. Near-0% interest rates have caused any excess cash to generate no return, which is a drag on investors’ returns.
And so companies have spent excess cash by buying back stock, which lowers share counts and therefore boosts the earnings per share (EPS) recognized by shareholders.
Buybacks aren’t going away
Many speculate that these massive corporate buybacks have actually been a key driver of this bull market. While that theory has been debated, it’s hard to argue that it’s been a non-issue. In fact, some Wall Street strategists have recently argued that future buybacks will be critical for ever higher stock prices.
“Buybacks will remain the key source of US equity demand while mutual funds and foreign investors will be net sellers,” Goldman Sachs David Kostin said on Friday.
“Companies have more cash than ever, so they have the ability to do this,” S&P’s Howard Silverblatt said. “This is not going away. This is growing.”
Sam Ro is managing editor at Yahoo Finance.