The bull market that began after the Great Recession has been propelled (in large part) by one factor: a stock buyback program. The bigger, the better, as far as investors were concerned. If you add up the amount of money the top 20 corporate buyback programs have spent in the past decade on their own shares, it comes out to more than $1.4 trillion, according to data from S&P Dow Jones Indices.
The buyback craze — which remains at record levels — has meant that the biggest buyers of stocks throughout the bull market run have been companies, not regular investors. But how many of those 20 stocks have outperformed the S&P 500 since 2009? Only five.
Now with stocks off their highs and many in bear market territory — a decline from an all-time high of 20 percent or more — it is becoming clearer that corporate treasurers are as bad as everyone else is when it comes to market timing. In fact, the buyback effect on stocks is waning, as evidenced by two popular exchange-traded funds that track buyback indexes.
The SPDR S&P 500 Buyback ETF (SPYB) is down this year by about –2.5 percent, trailing the S&P 500, which it also has trailed over the past one-year and three-year periods, according to Morningstar data. The Invesco BuyBack Achievers ETF (PKW) is down by about 4.5 percent this year, and also has trailed the S&P 500 in recent years. Over the past 10 years, though, it is a different story. The S&P 500 Buyback Index has generated a return of 17 percent on an annualized basis, beating the S&P 500 by 3 percent.
Here is the problem with buybacks, even if the long-term data makes a decent case for them: This is the wrong market to still be doing them.
Buybacks work best when stocks are coming out of a bear market because the buybacks act as an accelerant. But companies spent too much of their cash without accepting that economic cycles do eventually proceed rather than stay in place, and eventually turn, and companies that do not have ample cash on hand heading into a recession are more likely to fail. That's what happened to GM in the last recession. GM bought back a ton of shares before finally needing to be bailed out by the government, $20.4 billion from 1986 to 2002 alone.
It is evident that the U.S. economy is slowing and the bull market is looking wobbly with almost half of the S&P 500 now in a bear market. So corporate officers would do well to make sure they have ample cash on hand. Some companies that have spent liberally on buybacks over the past decade continue to beat the market, but not many, especially after the recent market rout.
According to S&P Dow Jones Indices on buyback programs through the third quarter of 2018 and Morningstar data on stock performance through Dec. 10, only five companies have managed to generate annualized returns over the past decade that are above the S&P 500's total return of 14 percent: Apple, Home Depot, Microsoft, Disney and Intel.
Other companies that spent billions on buybacks will soon be wishing they could have that cash back. Here are three that should make investors mad.
Take General Electric. Last Friday the company made official its dividend cut to just a penny a share. It has a massive debt load that is rated just one notch above junk, and its cash flow is a growing worry for investors. I'm willing to bet anyone that the $46 billion GE spent over the last decade on buybacks, according to S&P Dow Jones Indices, and the $24 billion the company spent on buybacks in 2016 and 2017 alone, would be better served in its checking account, giving it more runway to restructure the company back to profitability.
Today the stock is in the $7 range, which means a share can't even buy you a meal combo at McDonald's. And with the dividend just a penny per share, you'll still need to reach into your pocket to pay the sales tax on your meal combo. By the way, GE was trading above $30 a few years ago. It's down almost 60 percent just this year alone.
IBM spent an eye-popping $83 billion on buybacks after the Great Recession, according to S&P Dow Jones Indices. A lot of those purchases were funded with cheap debt. So with the purchase of open-source cloud software Red Hat, in a transformative deal to get IBM back to growth, it is planning to issue even more debt for the $34 billion deal.
It makes sense to use a combination of cash and debt when making deals, especially when rates are low. But a company would do better taking on debt, cheap or not, for reinvesting back into the business, not on buybacks that over the long term don't help a company's stock if business results don't justify it. My frustration with IBM's approach can be summed up in this question: After taking on debt for buybacks, now you want to take on debt for an acquisition?
With IBM's stock down over 20 percent this year and having been stagnant for years, the company could have used its cash much earlier during a difficult transition from mainframe technology to open-source software, cloud computing and artificial intelligence.
Finally, there's Citigroup, which announced a buyback of more than $15 billion about a year and a half ago and is No. 20 among all companies buying back debt over the past decade, at $45 billion in share repurchases. With the yield curve either flat or inverting, investors are concerned that the bank's earnings will be crimped. The stock is down by over 20 percent this year. Well, maybe now that it's down, it might be a good time to crank up its buybacks, but so far shareholders haven't seen a dime of return.
It is a problem that is pervasive in the bank stock sector. J.P. Morgan CEO Jamie Dimon has said several times recently that he prefers reinvestment in the business to buybacks, especially when stocks are pricey. That doesn't change the fact that J.P. Morgan is No. 8 among all companies in share repurchases over the past decade, with over $67 billion spent on buybacks.
Investors should be furious with the managements of some of these companies. The most famous one of all, Warren Buffett, sold all of his IBM in spite of IBM's buybacks. Just last quarter Berkshire bought $4 billion worth of J.P. Morgan shares. Buffett has remained a fan of buybacks when done for the right reasons and done after careful analysis of a company's intrinsic value. He bought back near $1 billion in Berkshire Hathaway shares earlier this year — but Berkshire also is sitting on more than $100 billion in cash.
Apple has bought back more than twice as much stock as any other company over the past decade, but it also has been generating the most cash in the history of corporations. Even after buying back $250 billion in shares, it has almost that much in cash on hand left in its coffers today — $237 billion at the end of the last quarter. Could Apple have used the $250 billion it spent on buybacks for more useful things like acquisitions? Only time will tell, but to me, every company in this market should be working harder to justify buybacks. Buybacks may have gotten the market to its recent records, but they are not a useful determinant of where a stock is headed from here.
I know that it is obvious to say that companies that get into trouble will need cash to survive, but it is infuriating to me when companies like GE, Citi and IBM spend on buybacks when they should've been reinvesting into their businesses or just saving for a rainy day. Nothing over the long haul can compensate for a misallocation of capital.
The point is that all companies eventually face obsolescence and recessions. Those are the times when cash is needed most. Amazon founder and CEO Jeff Bezos is very open about how Amazon could one day face bankruptcy. As hard as that is to believe, it has happened to many companies that were industry leaders. Apple faced bankruptcy twice in its corporate history. Maybe it should learn from its own past and realize that in the world of technology, every company is always only one product ahead of the new thing.
In the last 10 years, there has been a big equity to debt conversion because that's what happens when companies borrow to fund buybacks. I think that's a danger in the next recession. Capital has been abundant in this era of cheap money, but that game is ending, and capital will become scarce in an era of tighter central bank policy. Once we are there — and we are getting closer — many of the companies that spent lavishly on buybacks will be wishing they had been a little more strategic with their cash.
—By Mitch Goldberg, president of investment advisory firm ClientFirst Strategy