Equity Wednesday : If You Can’t Improve Earnings, Then Improve the Earnings Per Share
Share buybacks – boon and boon and boon.
Earnings surprises are at a 3 year high at 70.4% but nowhere near the 2009 levels where 80% of companies beat earnings estimates.
And here is what the entire picture looks like.
Because real earnings are not really multiplying as exponentially as the S&P although future earnings look good as SHADOW NUMBERS.
Total Earnings of the S&P 500
And buying back shares does wonders to the Debt/Equity ratio, even if you raise debt to buy back the shares because driving the share price up for the entire market cap nullifies the smaller amount of debt.
Debt/Equity Ratio
Financing buybacks with borrowings increases interest expense which saves the company on tax.
All this is possible because of ZIRP (Zero Interest Rate Policy) and low inflation that allows ZIRP to continue.
To the academic, buybacks could pose as a moral hazard because it is usually the least fruitful method of deploying investible company cash that could be used to further R&D, boost expansion, employment, employee training and other long term investments in plant and equipment.
Yet there is no universal regulatory oversight on the buyback business because it is the company (and shareholders’) prerogative.
The only case I can recall of late has been the Fed rejecting Citibank’s stock buyback and dividend plans back in March and back in 2012, after the bank was found failing the Fed’s stress test. http://www.marketwatch.com/story/citi-four-other-banks-see-capital-plan-rejected-by-fed-2014-03-26
For the rest of the non financial S&P 500 companies, buybacks are hard to fault even if bonds were issued for the precise purpose of funding share buybacks.
And here the markets are. Companies facing competitive pressures to outdo each other in the buyback game. It has become a follow the Jones fad to install those buyback programmes or face shareholder backlash.
This brings to mind the exact circumstances that banks were all caught in the sub prime net. Competitive pressures that overrode reasoning, leaving investors all high and dry.
This is exactly why you need to look at debt to equity as well as p/e and also look as the balance sheet closely to see how much cash the company has and how that has changed over time.
Debt/equity has fallen a lot because equity has gone up.
Does that mean that bonds are cheap ?
I also like interest cover but that number has come to mean little these days.