Five Stocks Poised to Benefit From Buybacks

Seven years into the bull market and there is only one main buyer that’s still driving up stock prices. We know individual investors still bear the scars of the financial crisis, and despite witnessing the major indices more than double from their 2009 lows they have been reluctant to invest. This has led to calling this “the most hated bull market ever.”

And maybe that moniker is well deserved once we drill down to look at what has been driving this bull market. Investors have clearly not been in a buying frenzy. Nor was the January sell off, which offered the 10%-15% correction that had been so elusive for the past few years, viewed as a chance to “buy-the-dip.” In fact, there is no love for stocks as money flows from equity funds have been negative over the past few weeks even as stocks rallied. So who’s been buying stocks?

The corporations themselves – in the form of buybacks. And that has been the case through most of this 7 year bull market. The graph below shows that households and retirement funds have been net sellers of stocks, even when the flow into ETFs is accounted for, over past 7 years.

Buybacks 7 year 3.15.16 (1)

And while buybacks were basically shelved for the first 5 weeks of the year during earnings season. But they are back in force with some $45 billion in repurchases over the past four weeks. If interest rates remain low we can expect 2016 to a record year for buybacks. Which is both a good and thing.

The Incredible Shrinking Stock Market

When a company buys back stock, it helps earnings per share results, since the profits are spread out over a lower denominator (shares), making the EPS look a lot bigger. As such buybacks represent a tailwind to share prices. It is estimated that the number of total shares outstanding of for S&P 500 companies has declined by 31% over the past five years. Basically, the stock market has been shrinking.

But that means companies are not investing in research, capital equipment or other items on which to build future growth. Goldman Sachs estimated that 27% of the cash companies spend in 2016 will be used for stock buybacks. That percentage is equal to what companies spent in 2015 and higher than the 25% in 2014. In total, SPY components will spend $608 billion this year on stock buybacks, even more than the $568 billion spent in last year’s zero rate environment.

William Lazonick, a professor of economics at the University of Massachusetts warns such unproductive use of capital bodes ill for the U.S. economy, stating, “in each year since 2010, corporate demand via buybacks and M&A has represented the largest source of inflow to the U.S. equity market.

And while buybacks may be a purer form of returning value to shareholders it also suggests companies can find nothing better to do with their money. You can see the impact buybacks and dividends have had on driving stock market returns.

Buybacks plus dividends 3.15.16

Prof. Lazonick says, “instead of investing their profits in growth opportunities, corporations.” He estimated the 449 firms in the S&P 500 that were publicly listed from 2003 through 2012 “used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock. Dividends absorbed an extra 37% of their earnings. That left little to fund productive capabilities or better incomes for workers.” He may not like it but there is no denying the simple math and impact it has on stock prices.

Biggest Shrinkers

Since buybacks seem to be fact of life we might as well try to benefit from it.   Here are five of some of best blue chip that will also be big buyers of their own shares:

Apple (AAPL) with its huge cash hoard is expected to remain the single biggest buyer in terms of sheer dollar amount. It contributed $35 billion of the roughly $580 billion in 2015 S&P 500 buybacks and is expected to buy another $30 billion in 2016. That’s about 5.5% of its current market capitalization.

Gilead Sciences (GILD) the big pharmaceutical company is expected to repurchase $12 billion of its own stock. Qualcomm (QCOM) has $5 billion earmarked for buybacks which is about 6.6% of its current market cap.

Coming a bit under the radar is Nike (NKE) which just launched a $12 billion buyback program to commence once the current $8 billion program ends. NKE is quite a bit lower since announcing the plan back in December. However, $12 billion is good for more than 11% of all NKE shares outstanding.

Finally, there is Alibaba (BABA) which while it has no firm plan in places most analysts expect it will almost certainly issue debt to make a large share repurchase. BABA launched a $4 billion buyback plan back in August that was supposed to be used over the course of two years. However, BABA spent nearly 70% of that $4 billion total in the two months following the buyback plan announcement. Time to dip into the well again.

But before becoming too enamored with buybacks one should consider how shares of IBM have fared. The company has been the poster child of buybacks and dividends, using nearly 75% of its free cash and shrinking its share base by 68% in just the past three years. The stock is down some 30% during that time period.

— Steve Smith

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About the Author: Steve Smith