The widespread pessimism among individual investors stands in stark contrast to the outlook among S&P 500 executives who bought back shares at record levels in the first quarter and appear poised to do so again in the second quarter, suggests Jack Bowers, fund expert and editor of Fidelity Monitor & Insight.
These insiders, who know more about future earnings growth potential than anyone else, can only be described as bullish. Despite higher borrowing costs, labor shortages, and the growing likelihood of a recession, many are coming to the conclusion that they are sitting on far more cash than is necessary to sustain operations. And many are seeing the potential return on their own company shares being greater than other opportunities for deploying capital, such as automation, paying down debt, or acquisitions.
Stock buybacks are a form of shareholder compensation. Unlike dividends, which compensate shareholders directly, stock buybacks reduce the number of outstanding shares. Other things being equal, this boosts earnings per share, because shareholders end up owning a slightly bigger slice of the company.
In effect, shareholders are compensated indirectly through stock price appreciation (which is taxed at lower rates than dividends if the shares are held for more than a year).
At the end of the first quarter (the latest period for which data is available), share repurchases were $281 billion for the first three months of the year, and $985 billion for the trailing 12-month period (an increase of 97.2% over the prior 12-month period). Both figures are all-time records.
According to Howard Silverblatt, Standard & Poor’s Senior Index Analyst, companies likely maintained their buyback activities in the second quarter, getting even more shares for the same expenditures, potentially providing an even greater boost to earnings per share.
Stock repurchasing activity was surprisingly widespread; 432 firms reported buyback activity in the first quarter, and 374 reported buybacks of at least $5 million. And the impact was significant, with 17.6% of firms buying back enough shares to lift earnings per share by 4% or more year-over-year.
The activity was less top-heavy compared with the past, with the top-20 firms accounting for 42.1% of the dollar volume, a significant improvement over the 51.8% in Q4 and a major improvement from 87.2% in Q1 of 2021. At the current level of 42.1%, the concentration of buyback dollars is similar to that of market capitalization, which for the top-20 stocks is around 35-40%.
The top spending buyback industries were communications services, technology, and financial services. This contrasts with the top dividend payers, which were consumer discretionary, utilities, and energy. But it was the health care group that saw the biggest increase over Q4, with repurchase activity rising 88.3% to $41.1 billion.
Compared with the amount of money that was paid out as dividends in the first quarter, companies spent more than twice as much on buybacks. Even over the 12 months ending 3/31/22, the S&P 500’s buyback yield was 2.74%, greatly eclipsing the index’s dividend yield of 1.63%. That made for a combined shareholder compensation yield of 4.36%.
Given the recent market decline, a return to the 5% combined yield level is easily within reach for the second quarter. That level of shareholder compensation would be similar to what occurred during the nine- year period from 2011-2019.
Clearly, corporate executives are continuing to reward shareholders at a healthy clip, and buybacks represent a steady stream of buying activity at a time when many individual investors have been selling.
Over the last month, many analysts and journalists have been comparing the current bear market with others in the past, arguing that we still have a long way to go before the market bottoms. It’s possible they’re right, but they are ignoring the fact that buyback activity on today’s scale was not present prior to 2006, and even in 2009 it was not ramping up the way it is now.
My suggestion: take those gloomy forecasts with a grain of salt. Many growth-stock heavyweights are pouring cash into their own company stock, so it should come as no surprise if the bear market in large-cap growth stocks ends in the near future.
Our Select Model has already re-embraced the large-cap growth segment. In the coming months, we’ll be looking to do the same in our other stock-oriented models.