The bull market has had a historic run. And, even as it ages and becomes more volatile, the S&P 500 has still not had the substantial correction that has been predicted by many. One factor that keeps stock prices from falling too far is stock buybacks. We are wondering, are buybacks keeping the bull market alive? And, what else are they doing?
Just a couple of months ago Forbes wrote about stock buybacks by Apple and other companies. The article is informative and helps shed light on one of the reasons that the market and especially the FANG stocks have not had a significant correction.
Stock buybacks were outlawed until 1982, when the SEC changed its rules to allow companies to repurchase shares on the open market, although doing so can artificially boost the stock price. CEOs and other corporate executives benefit the most from this behavior because their compensation, unlike that of rank-and-file workers, is closely tied to stock performance.
Between 2015 and 2017, U.S. publicly traded companies across all industries spent three-fifths of their profits on buybacks. The low-wage restaurant, retail, and food manufacturing industries spent 137%, 79%, and 58%, respectively. The restaurant industry borrowed money or used cash on its balance sheet to exceed the amount of its bottom line.
The argument that Forbes makes is that money which could have gone to higher wages or other employee benefits has gone to propping up stock prices. This disproportionately benefits upper levels of management. Our take on the practice is that buybacks are keeping the bull market alive by artificially inflating stock prices.
Stock Price versus Market Cap
When the market would normally take the price of a stock downward, stock buybacks prop up the stock price. However, this practice reduces the number of shares of stock available. Thus, if a company buys back 10% of its shares in order to increase the stock price by 9%, the market capitalization of the company, its total worth, is unchanged. If the company buys back 10% of its shares just to keep the stock price the same, the market cap of the company falls by 10%. If you have kept your shares in that company you now own a larger proportion of a company that is worth less than before. Stock buybacks are a common tactic used by old and successful companies with lots of cash that are now failing as their business plans become dated or simply because the economy is taking a downturn.
Buybacks and the Economy
The Forbes article goes on to note that when companies use buybacks to prop up stock prices and compensation for upper management the same buybacks rob workers of the pay increases or bonuses that otherwise would funnel into the economy and help everyone.
How Long Can Buybacks Prop Up a Stock Price?
Buybacks will continue so long as a company has the cash or credit to buy back its own stocks. How long that lasts is also determined by the needs of the company to simply run its business. As profits sag, a company will eventually need to use its resources to run the business and not prop up the stock price. At that time one might expect a more substantial correction than might normally have happened because the market forces poised to take the stock price down will be unopposed by the artificial action of buying back stocks. In other words, we might expect a stock to crash instead of correct when it has been supported artificially by buybacks for an extended period. Investors who are now leaving various stocks are likely looking at intrinsic stock value and not stock price to make their decisions.
Market Watch adds to the concern about a pending market correction or worse with an article about damage done to the stock market in recent weeks.
Acampora said he believed that the entire stock market itself would go into a bear market and said the current dynamic in the market was eerily similar to the stock-market crash of 1987, when the Dow slide a historic 22.6% in a single day on Oct. 19 of that year.
When we see the market fall on day and recover the next, one might think that solid long term investors are stepping in to take advantage of lower prices. However, it would appear that companies are using the downturns to buy back stocks at a lower price and especially to prop up the stock price. In this sense it would appear that buybacks are truly keeping the bull market alive and the time will come when sellers overwhelm the ability of the Apples of the world to buy back and prop up stock prices.