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DataTrek’s Colas on Stock Buybacks

Traders Magazine Online News, October 9, 2018

Nicolas Colas

In a recent newsletter, Nicolas Colas, co-founder of DataTrek Research revisited the topic of corporate buybacks. Traders Magazine is republishing his article with permission.

“Stock buyback activity in US equity markets is simply staggering at present: $646 billion for the 12 months ending June 2018 for the companies of the S&P 500. Total dividend payments aren’t far behind, at $436 billion. The bright spot: the total of the two is $1,082 billion, only 90% of 12 month trailing operating earnings of $1,197 billion. That’s a better buffer than existed in 2015/2016, and an underappreciated positive for US stocks.

“You can’t restate a dividend, Wheels…”

That statement requires two quick explanations. First, my hedge fund nickname was “Wheels” because I covered the auto industry. And, because on my first day of work at SAC Capital I drove up in a bright yellow Porsche 911. Stevie made some vocal inquiries on this point in front of the room. He wasn’t a fan. The nickname stuck, however, even when I found a more appropriate ride.

As for the fundamental observation, that came much later when I worked for an immensely talented private value-oriented investor. He was a fan of big payouts. To him, they proved out the cash generation ability of a company better than anything else. Today we swim in his intellectual wake to address a basic question about US equity prices.

There is, at present, a legitimate concern that we are at the top of a US corporate earnings cycle. Tax cuts have goosed net margins, as has strong economic growth. How much longer can this last? One observation on that count:

•             FactSet currently shows that Wall Street analysts have 5% revenue/10% earnings growth penciled in for 2019.

•             Those neat round numbers are analyst-speak for “We’re totally guessing here.”

•             Anything from trade/tariffs to economic slowing will see those estimates revised quickly downward.

Also, as we noted yesterday there is no fresh investor money flowing into US stocks in 2018; the marginal buyers are companies themselves as they repurchase stock. On top of that, dividend yields – the S&P 500 pays 1.7% - are well below 1-year Treasury payouts at 2.58% today. If (or really, when) US corporate earnings decline, buybacks will be slashed first and dividends will shortly follow. It has always been thus, after all.

To assess just how much risk US corporates face on their buyback/dividend outlays, we pulled the historical data from Standard & Poor’s. We did this math earlier in the year for you, but it is time for a refresh given strong first half earnings results and outsized Q3 stock rally.

Here’s what the numbers show:

#1. Unlike 2015/2016, the companies of the S&P 500 are no longer spending 100% or more of their operating profits on buybacks-plus-dividends. In those years, the ratios were 108% and 102%, respectively. For the 12 months ending June 2018, dividends-plus-buybacks were 90% of operating earnings.

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