Stocks have been on a tear recently with the S&P 500, Nasdaq, & Dow Jones Industrial Average at record highs. As of last Friday, 89% of S&P 500 companies have reported earnings results for the third quarter. Of those companies that have reported, 81% have posted earnings above consensus estimates. According to FactSet, this figure is above the 5-year average of 76%. The figures are quite impressive. If earnings continue to beat estimates at this pace, the third quarter will tie with the second quarter of 2018 for the fourth-highest percentage of companies reporting positive earnings results. This is good news for those concerned about inflation fears as companies’ profits have not been hurt, indicating they have been able to manage their pricing while maintaining consumer spending. And that is not the only news that investors have received this earnings season.
During earnings calls, companies have been citing supply chain issues and inflationary concerns – which have largely been expected – but one other announcement investors have been happy to hear is about company share repurchase programs. Shareholders are pleased to hear these comments since a company’s share repurchase program effectively increases shareholders’ “piece of the pie”. Companies go out to the open market and “buy back” their own shares which limits the number of shares outstanding or available. Thus, each shareholder will have an increased claim on the proportion of the company’s assets – getting more of the “pie”.
In June, we discussed the rapid rate of share buybacks that occurred in the second quarter of this year. You can find the article with the following link. The fast pace of buybacks did not stop in the second quarter. According to estimates by Reuters, total U.S. corporate stock buybacks are on track to hit a record for the third quarter. So far, S&P 500 companies have disclosed buybacks totaling $145 billion for the third quarter and will likely surpass $224 billion by the time all earnings reports are out. This amount would be larger than the $223 billion record set in the fourth quarter of 2018. At this pace, S&P 500 company share buybacks are on track to top $760 billion, falling short of 2018’s record-setting $806 billion.
It is no surprise that the Biden administration has taken a look at the amount of money companies are spending on buying their shares. According to the Wall Street Journal, the administration is proposing a 1% tax on the amount companies spend to repurchase their own shares. If shown to gather a large movement, this move could increase the pace at which companies are buying back their shares. According to the White House, the tax could potentially raise over $100 billion throughout 2030. If the proposal passes, companies will surely think twice about spending cash on share repurchase programs. Companies engage in buybacks because of the ease in changing the pace, or outright stopping their buybacks, without much of an effect on their share price. Compared to dividend payments, investors expect the company to maintain the amount or increase it further once a dividend is increased
It appears that 2021 will be the year of giving back as investors see the value of their shares increase due to companies using their excess cash more freely. If this trend continues into 2022, stocks price advances could continue regardless of the Fed’s move to slow down its gratuity in the form of monthly asset purchases. And an improving economic environment can surely justify the prices they are paying to repurchase their shares. As previously mentioned, before going out to buy shares of companies with active share repurchase programs, it is important to analyze whether the company’s balance sheet is healthy enough to engage in share repurchases without eroding the cash cushion that many have amassed throughout the year. After all, if we enter another period of uncertainty companies would surely look back on all the giving they made.