Judging by the recent flurry of share buyback announcements, Corporate America is increasingly confident the worst of the economic slump has passed. After two years of belt tightening, stock buybacks are running at their highest level in two years as companies start to look for ways to deploy the record levels of cash on their balance sheets.
Buybacks are viewed as sort of a way-station to the more aggressive ways to spend: acquisitions and capital expenditures. Those expenses imply a long-term strategic bet by a company on earnings potential and growth. "It's just a sign that more companies are confident in the economy going forward," said Rob Leiphart, market analyst at Birinyi Associates in Stamford, Connecticut. "Buyback authorisations are cyclical and do tend to move with recessions and expansions."
In recent weeks companies announcing authorisations for buybacks include Philip Morris, which unveiled a $12 billion share repurchase plan, and Lowe's Cos Inc, which plans to buy back up to $5 billion worth of its stock. Other bellwethers announcing big buybacks include WellPoint Inc, Colgate-Palmolive Co, UnitedHealth Group Inc and Amazon.com Inc.
New stock buybacks have been particularly robust in the latest earnings reporting season, averaging $1.6 billion daily, the highest level in almost two years, according to data from investment research firm TrimTabs. Buybacks reward shareholders by reducing outstanding shares, driving up the price of existing stock, and improving earnings-per-share figures. But they can be cancelled more easily than a big acquisition. Investors tend to be forgiving if companies suspend buybacks when the going suddenly gets tough, unlike cutting a dividend or abandoning capital expansion plans.
BIG BUYBACKS, BIG CASH PILE: In the week through February 26, the amount of authorised share buybacks by US corporations hit $13.2 billion, compared with $1.07 billion of authorisations announced in the week to February 27, 2009, according to data from Birinyi Associates.
The year-to-date tally is $68.5 billion, compared with $125 billion of authorisations for all of 2009, a year that saw a 65 percent drop in buyback authorisations from 2008's $359.8 billion. The hoards of cash for buybacks also spells good news for the broader equity market. "There is no question in my mind that we're at the early stages of a major stage of more stock buybacks and merger and acquisition activity," said Carmine Grigoli, chief US investment strategist at the equities division of Mizuho Securities USA in New York.
"That should keep stock prices rising. It's powerful enough to keep the equity market moving higher." J.P. Morgan estimates that S&P 500 companies currently have $3.2 trillion of cash sitting on their balance sheets. Excluding the financial sector, the cash pile is $1.1 trillion, or 11 percent of assets, a 60-year high and well above the long-term average of 8 percent. This makes it likely 2010 will mark a big turnaround in share repurchases, and the revival in capital expenditures and M&A should follow after a muted 2009.
Stock repurchases, M&A and the ramping up of capital spending and dividends have historically been inversely correlated with cash balances. "We believe one catalyst to buy equities is the eventual deployment of the excess cash held by S&P 500 companies," said Thomas Lee, J.P. Morgan chief US equity strategist.
He said confidence in the sustainability of the recovery will be critical to more purchases. Some of the cash is already making its way into deals this year, with Coca-Cola Co's clinching a deal to buy the North American operations of its top bottler for about $13 billion and Schlumberger Ltd agreeing to buy Smith International Inc in a $11.34 billion all-stock deal.
Global M&A has reached $400.8 billion in 2010 so far, up 4 percent on the same period last year, according to Dealogic's latest review of February M&A. The top 10 M&A deals in February have involved six US corporations as acquirors. Capital spending could also rise. J.P. Morgan's Lee estimated that there was a $107 billion potential increase in capital spending, and the largest sectors likely to deploy that cash were discretionaries, industrials and healthcare.
But, as expected, the damage sustained by the financial services sector over the past two years and scrutiny from Washington makes it unlikely that banks will be announcing share repurchases or other major capital expenditures anytime soon. Not every company is thinking this is an appropriate time for buybacks.
Apple Inc, under intense scrutiny about how it would use its $40 billion cash pile, said it would rather save the money for bolder risks like acquisitions instead of buybacks or cash dividends. A rumour of a potential Apple share split stoked a frenzy last week, helping stocks reverse a sharp drop late in the day.
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