
Dividends and Buybacks Now Larger Than Total Reported Earnings for Entire S&P500 - Fifth_Star
https://thesoundingline.com/dividends-and-buybacks-now-larger-than-total-reported-earnings-for-the-entire-sp-500/
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nostrademons
This is how its supposed to work. The whole reason stocks have fundamental
value in the first place is because they're claims on the future profits of
the company. 100% of a company's earnings legally belongs to the shareholders;
it's nice to see them actually returned to the shareholders (vs. blown on
overpriced acquisitions) for a change.

It does mean the end of a cycle, though, and not just a "stocks go up, stocks
go down" cycle. It's rational for corporate management to retain earnings and
invest in future growth opportunities when the expected returns from those
growth opportunities are greater than the cost of capital. That they're
returning capital to shareholders, even in an era of historically low capital
costs, indicates that they can't find growth opportunities at any price.

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dustinmoorenet
But they aren't just using their earnings. They are borrowing too.

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nostrademons
That just means that at current interest rates, the stock's forward P/E
exceeds the rate of interest. It's rational to borrow money to buy stock if
the earnings spun off by the stock exceed the rate of interest. You're
basically arbitraging against the bank: the bank gives you money to buy out
people who think the stock is overvalued, you give them a set amount of
interest for the money, and if it turns out you're right and the stock's
future earnings exceed the price of that money, you pocket the difference at
the expense of people who left the market. If you're wrong and earnings are
less than the interest rate, it's reflected in net income, the stock drops,
and you (and the rest of the shareholders) eat the difference, often in a
dramatic fashion.

With low interest rates, high corporate profits, and low growth, I'd expect to
see a lot of debt added to balance sheets; it's a way to lever up the capital
structure to the benefit of existing shareholders, as long as profits remain
high and interest rates remain low. (And corporate bonds/loans are usually
fixed interest, so the interest rates are locked in until they need to go back
to the debt markets.)

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MarkPNeyer
> If you're wrong and earnings are less than the interest rate, it's reflected
> in net income, the stock drops, and you (and the rest of the shareholders)
> eat the difference, often in a dramatic fashion.

Or you’ve already moved on, and the next CEO eats the difference. The
incentives between those two vary wildly.

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y96V89C668e7Q74
I was taught in economics classes that buybacks make sense when there is
nothing the company believes it can spend the money on instead to increase its
profit. If this is true, should we be concerned that this is a market signal
that the economy as a whole is running out of opportunities to invest in new
technologies and instead just trying to hold onto its own value? If that is
the case, I imagine that buybacks could be viewed as a signal that the market
is moving more in the direction of being zero-sum and less in the direction of
expanding. And if that is true, does that suggest that this phase of growth in
the business cycle is coming to a close?

I agree with the logic behind the arguments that a company buying its own
stock should be a signal that the company believes in its business and
valuation, but it also seems that many companies that also believe in their
business and valuation also sell stock to raise money in order to expand, with
the belief that the sale will result in individual stocks increasing in value
even after the dilution. It seems hard for both cases to be true, but perhaps
they are.

If this logic is sound, it seems that we should be at least somewhat concerned
about this.

Also, I didn't understand how cheap credit is encouraging buybacks if
companies aren't buying their own shares on credit. Would someone be able to
explain this better than the article? (Thanks!)

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CydeWeys
I was taught in economics classes that buybacks shouldn't increase the stock
price at all, which clearly isn't true in practice. It ends up being more
complicated than the simple models would suggest.

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guelo
How could the price not go up? I understand buybacks as reverse dilution. Each
share represents a larger percentage of the company, therefore it is more
valuable and it's price should be higher. Is that wrong?

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mantasm
The company becomes equally less valuable after a buyback.

Consider a company with value of $1000, with 100 shares outstanding. Each
share is $10. Buying back 10 shares, the company spent $100, so the company is
now worth $900 and has 90 shares outstanding. Each share is still $10.

This is the basic model that shows share price should be unaffected by
buybacks, but there are other effects. The buyback could signal to investors
that the company is unlikely to be inefficient with capital, so investors
would value the company at $910 instead of $900.

Alternatively, in a demand/supply model of shares, the buybacks could have
exhausted some of the supply of shares, so the valuation for the company
settled on by the rest of the market is higher.

There's no clear answer here, but reality is probably somewhere between these
models.

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darawk
I think you may be confusing market cap with share price. Market cap does not
generally increase with buybacks, only share price does.

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llamataboot
Can't see this ending without a lot of pain. Credit is so easy that it becomes
easier to reduce the amount of shares out there to prop up their price than do
what capital markets are supposedly designed for - offering more shares to
invest in capital. Yet raising interest rates would crash the market. At some
point true price signals will leak through and the tiny hole in the wall will
become a flood...

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__blockcipher__
Once a company has no need for more cash, there is no point to sell shares.
The whole point of a IPO is to fund growth / give founders and early employees
a payout.

Share buybacks aren’t about propping up the price (when done correctly).
They’re about tax efficiently increasing your ownership share. Or you can
think of it as paying money now to reduce the amount you need to pay in
dividends, all else equal.

Share repurchasing is just a tax efficient way to return money to
shareholders. People love dividends yet look at buybacks as insane. Why?

* Note: buying back shares when your company is overvalued is insanity. I’m not endorsing that. But if you’re in a situation like AAPL, they are hands down the correct move.

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lovich
Because it's difficult to distinguish between executive leadership trying to
efficiently return money to shareholders vs propping up the share price so
that they see a personal benefit via their own shares increasing or via
contractual bonuses.

Given that there's an incentive to spend other peoples money(shareholders who
bought shares) to increase their own(via bonuses, salary, or granted shares)
it's fairly safe to assume that execs are following the incentive

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djakjxnanjak
“Spend other people’s money” is a really weird way to put it IMO - people
chose to invest in the company because they thought it was a good investment.
Investors would rather have the stock than the cash they paid for it. When the
company does a buyback, the shareholder investment in the company becomes more
concentrated. Each share represents more stock and less cash, making it
possible to construct a higher-equity lower-cash portfolio. This more purely
fulfills the investor’s revealed preference of owning the stock. If they
change their mind, they can always sell.

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lovich
I'd agree that it would be a weird way to put it if both sides had the same
level of information. In this case execs okaying the buybacks have access to
more accurate and immediate information than the potential investors and they
have a way to funnel that investor money into their own pockets. In this
situation I stand by characterization of this

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jjwhitaker
After the 2017 tax bill this was bound to happen. consolidating stocks allows
greater control over the corporation by the high % owners, minimizes activist
investors, reduces accountability, and further funnels profit to the top.
Whatever that "poll" advertisement is at the bottom with a caricature of AOC
was misleading and dishonest at best. What agenda is this site pushing i
that's their biggest ad on this article?

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twoquestions
The site probably doesn't control the ads that appear, and such an ideological
slant doesn't look evident looking at the titles of their other articles.

The first bit is bang-on.

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eej71
For some counterpoints, consider this paper from Cliff Asness of AQR fame.
[https://www.aqr.com/Insights/Research/Journal-
Article/Buybac...](https://www.aqr.com/Insights/Research/Journal-
Article/Buyback-Derangement-Syndrome)

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mikhailfranco
Surely it ends when the corporate Credit Default Swap (CDS) rate rises, and
credit rating drops, so the interest rate paid by the company rises when they
have to refinance their bonds. Eventually, interest on bonds exceeds cashflow,
and they have to borrow more to pay interest (Ponzi phase).

At the margin, the lowest investment-grade BBB company drops one notch and
becomes High Yield 'junk'. Then insurance companies and pension funds with
fiduciary obligations must divest themselves of the bonds, so they sell and
force the yield (interest rate) even higher.

Companies have borrowed too much to perpetuate buybacks, jack up the share
price, and reward executives with profits on share options. Half of all bonds
are at BBB, just one downgrade from junk [1]. This situation is highly
unstable, just one snowflake will create an avalanche of downgrades, and a
true Black Swan will bankrupt many companies [2].

These companies have run off the cliff, and if they look down into the abyss,
they will fall (e.g. GE [3], IBM). As with sub-prime mortgages, CDOs and MBSs
during the Great Financial Crisis, pulling the trigger depends on the ratings
agencies. Last time they were asleep, or perhaps complicit (euphemism for
corrupt). Let's see what they do this time.

[1] [https://www.marketwatch.com/story/half-of-investment-
grade-b...](https://www.marketwatch.com/story/half-of-investment-grade-bonds-
are-only-one-step-away-from-junk-status-2019-01-07)

[2] [https://www.zerohedge.com/news/2019-03-05/bis-warns-
market-c...](https://www.zerohedge.com/news/2019-03-05/bis-warns-market-crash-
risk-looming-fire-sales-over-mass-bbb-downgrades)

[3] [https://www.zerohedge.com/news/2018-11-13/collapse-has-
begun...](https://www.zerohedge.com/news/2018-11-13/collapse-has-begun-ge-now-
trading-junk)

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mdorazio
If you need evidence that our economy is at least partly broken, this is it
right here. Companies that are swimming in cash reserves are using their money
to artificially boost shareholder returns instead of actually investing in
things like capital expenditures, R&D, or higher salaries. On one hand (as the
article points out), this is driven by cheap credit, but on the other hand I
think the question needs to be asked: have large corporations just run out of
things worth investing in?

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__blockcipher__
Stock buybacks aren’t artificial boosting. It’s the correct move when your
company is undervalued and you don’t have better investment options.

See Apple for an example of doing it right.

See Chipotle for an example of doing it wrong.

~~~
challenger22
It's also a more tax efficient way of distributing returns to shareholders
than dividends. GP does not know what he's talking about.

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mikhailfranco
Credit is attractive for two reasons:

1\. Interest rates have been held artificially low by the Fed and other
Central Banks, which have also flooded the financial markets with trillions of
new dollars/euros/yen.

2\. Interest payments are tax deductible, but dividends are not. Debt and
equity should be treated equally.

Also, there are now many _weak_ corporate bonds (CoCo, convenant-light), which
mean that bondholders have fewer rights and priorities in the line of
creditors, should the company get into financial difficulties. So the debts
are treated as bonds for the purposes of taxation, but the rights of the
bondholders are little more than shareholders - a double whammy for the
company makes it a simple decision.

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ohiovr
1\. Companies are borrowing money and going into debt to buy their own stocks.
2\. Some stock holders and insiders have huge holdings, a perfect supplier for
the stocks to buy. 3\. Stock volume exploded soon after trump was elected in
the s&p 500 and the Dow. But a comparable surge in volume in the Russel 2000
and NASDAQ is not there. 4\. As a result of the buying pressure, stocks rise,
the market looks to rise in value. 5\. Eventually money is not cheap to borrow
any more. 6\. More than 50% of the buying power suddenly stops.

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thisisit
This is not a good sign. One of the important things for companies to do is to
turn the total earnings into a stable flow of cash.

But if cash outflow is larger than inflow then companies are mostly sitting on
negative cash flow. The difference is being covered up by borrowing at low
rates. These loans put strain on the future cash flow. Without any reserves to
fall back on there might come a time when these companies will be strapped for
cash.

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donjigweed
Buyback Derangement Syndrome

[https://www.wsj.com/articles/buyback-derangement-
syndrome-15...](https://www.wsj.com/articles/buyback-derangement-
syndrome-1534460606)

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anigbrowl
This sounds very sustainable and rational.

