Trader Talk

Why Apple is joining the ranks of the buyback monsters

Trading the Apple plunge

The stock buyback craze has continued into the second quarter, and the cumulative effect of that craze—now almost two years old and counting—is really mounting.

First, one clarification: Many companies buy back stock, but they use it to pay out options they give out to employees. What investors care about is when there is an actual share count reduction, because that increases the earnings per share and decreases price-to-earnings levels.

By that measure, the reduction in share count has been notable for the last five quarters, and is continuing into the second quarter.

The trend is up. Twenty percent of S&P 500 companies have reduced their share count by at least 4 percent year over year in each of the last five quarters, and that appears to be continuing into the second quarter, according to Standard and Poor's.

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As of last night, 92 companies have reported; 20 have reduced their share by at least 4 percent year-over-year.

That means earnings is 4 percent higher and P/E is 4 percent lower than a year ago for those companies.

One shining example is Apple, which has reduced its share count by 4.7 percent year-over-year, and 10.3 percent in the last two years, meaning earnings are 10 percent higher than two years ago, regardless of whether sales were higher or costs were lower!

Pretty cool, huh?

Here's a few other companies that have reported recently, along with their year-over-year share count reduction:

This is just year over year. Several companies have become "buyback monsters," aggressively buying back their stock year after year.

Two good examples are IBM and ExxonMobil.

IBM has been aggressively shrinking its float for five years, though it has slowed down recently. In the second quarter of 2010, IBM had 1.26 billion shares outstanding. In the same quarter of 2015, five years later, it had reduced that to 984 million shares.

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That's a share count reduction of 22 percent.

Let me try to make this more real for you. Suppose IBM reported $1 billion in net profits for Q2 2010. (It actually reported more than $3 billion, but bear with me.) So $1 divided by 1.26 billion shares outstanding equals 79 cents earnings per share.

Now let's fast forward to the second quarter of 2015. Suppose the same net profits, $1 billion, but this time there are only 984 million shares outstanding.

$1 billion divided by $984 million equals $1.02 earnings per share.

That's 79 cents earnings in 2010, and $1.02 in 2015. Same dollar profit. Different earnings.

Aren't buybacks wonderful?

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Buybacks are beloved by investors, but there is a dark side to them. It's easy for investors to fool themselves into believing that earnings are improving due to some kind of organic (sales) growth, but in many cases, that just isn't true.

When it comes to buying back stock, Apple and IBM are a bunch of pikers compared to ExxonMobil. ExxonMobil has been aggressively buying back stock for years, really since the Mobil deal in the fourth quarter of 1999.

You think I'm exaggerating? The share count of the combined company at the end of 1999 was 6.95 billion shares. Today it's 4.18 billion, as of the first quarter.

That is a reduction of 39.9 percent in the share count. Think about that: a 40 percent reduction in shares, and a 40 percent increase in earnings, all other things being equal.

See why investors love buybacks?