US equities continue to break all-time highs, but you’d be wrong to think it was Mr and Mrs Average driving the market and enjoying the ride.
In fact, the biggest buyers in recent years have been companies repurchasing their own shares.
Share buybacks have become increasingly popular as companies have built up large cash piles and become more open to rewarding shareholders. Cheap money and a reluctance to invest in new plant and machinery amid a fragile economic recovery have also helped.
The path to higher share prices is a straight one. Fewer shares in issue mean higher earnings per share and – other things being equal – higher share prices.
According to FactSet’s Buyback Quarterly, share repurchases grew 50% year-over-year to US$154.5 billion in the first quarter of 2014. S&P 500 quarterly buybacks are now at their highest level since 2007.
And it has been firms in the information technology, materials and industrials sectors that have led the way with buybacks far outstripping cash inflows. In the materials sector, for example, companies spent almost $2 in buybacks for every $1 of adjusted free cashflow in the year to end of March 2014.
But will the trend slow down as high valuations and higher interest rates make buybacks more expensive?
Gary Black, global co-chief investment officer at Calamos Investments, is optimistic we would see more. ‘As a percentage of market capitalisation, buybacks are at their highest level since the third quarter of 2011,’ he said. ‘We expect the heightened buyback activity to continue in the quarters ahead.’
FactSet is not so sure the good times would continue. It pointed out that five of the top 10 spenders in the first quarter of 2014 were not traditionally big spenders, while Apple and IBM – who repurchased a massive $27 billion between them in the quarter – seemed ‘poised to slow their repurchase activity’.
But will, as some commentators think, the buyback trend curtail sustainable economic growth as companies boost their earnings per share at the expense of expanding their workforce or developing new products? Economists at JP Morgan have claimed that the notion of US companies not investing in their businesses is exaggerated, although not entirely untrue.
‘It is certainly true that US companies spend far more money on share buybacks than those in other regions,’ said Patrik Schöwitz, a strategist at the firm’s global multi-asset group. ‘But it is far from clear that buybacks have held them back from investing in the business.’