Stock buybacks hit a record $1.1 trillion, and the year’s not over

Trader Talk

It’s official: This is an all-time record year for corporate stock buybacks.

Announced buybacks for 2018 are now at $1.1 trillion. And companies are using their authorizations. About $800 billion of stock has already been bought back, leaving about $300 billion yet to be purchased. We’ve seen buyback announcements recently from Lowe’s, Pfizer, and Facebook, but in the last few days, as stocks have moved to new lows, companies are picking up the pace of activity.

Several companies have announced new buyback programs, including Boeing, Johnson & Johnson, Universal Health Services, Shoe Carnival, and Playa Hotels, and several have announced accelerated buyback programs:

Allstate, for example, announced it had just bought back $1 billion in stock using an existing buyback program. Lincoln National, whose stock is down 18 percent this month alone, also announced an accelerated buyback.

What’s all this activity mean? It’s a sign that many CFOs believe their stock is undervalued. Traders tell CNBC much of the buying is based on the belief that the recent spate of selling is due largely to political issues (Brexit/China tariffs/Italy) that will resolve favorably and that global economic weakness may not be as pronounced as markets believe.

Will the buybacks continue into 2019? The answer is yes, providing two important conditions continue:

1. Companies continue to throw off significant free cash flow. While some companies borrow to fund buybacks, most fund them through free cash flow, which has been strong for the last several years. If there is a significant economic slowdown, that cash flow will likely diminish, and the pace of buybacks will diminish as well.

2. Companies need to continue to believe that reducing share count and boosting EPS is a more valuable use of their cash than making investments elsewhere, like actually investing in their businesses.

It’s sad but true. Companies are obsessed with controlling earnings per share, which is the key to maintaining higher stock valuations. It is easier to control earnings per share by purchasing stock, and companies get addicted to that process. Buying back stock often provides an incremental boost to earnings per share growth, and when companies stop doing that, accomplishing that goal becomes more challenging.

So the critics of corporate buybacks and dividend raises are correct. It is a form of financial engineering that does not do anything to improve business operations or fundamentals.

It also plays into the hands of the people who were critical of the tax cuts, arguing that obsessing over ways to boost stock prices helps the investing class but not the average American.

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