By Michael Rapoport and Theo Francis
Companies' record stock repurchases this year are causing
profits to appear stronger and fueling the stock market's record
run.
A key driver in the surge of stock buybacks was last December's
tax overhaul, which lowered companies' tax bills and freed up funds
that many companies are using for share repurchases.
S&P 500 companies bought back a record $189 billion of their
own shares in the first quarter, and a similar number -- if not
more -- is expected for the second quarter, according S&P Dow
Jones Indices. By contrast, S&P 500 buybacks totaled no more
than $137 billion in any of the six quarters before the tax
overhaul.
Stock buybacks make profits appear better by boosting per-share
earnings, a metric that investors frequently use to justify a
company's stock price. Buybacks reduce a company's share count,
spreading the profits across fewer shares. As a result, companies
can report a bigger percentage increase in per-share earnings than
the profit results alone may show.
Among the more aggressive companies in buying back stock, Apple
Inc. repurchased 112.8 million shares in the quarter that ended in
June, contributing 5 cents to its earnings of $2.34 a share. Union
Pacific Corp. repurchased about 4% of its shares in the second
quarter, helping earnings per share climb substantially faster than
net income. Thanks to buybacks, Southwest Airlines Co.'s quarterly
per-share earnings rose even though its profit fell from a year
earlier.
For the S&P 500, per-share earnings in the second quarter
rose about 25% from a year ago -- a full 2 percentage points faster
than net income, according to data from Thomson Reuters. "It would
be fair to assume it is all from buybacks," said David Aurelio,
senior research analyst at Thomson Reuters.
The higher per-share earnings have helped lead investors to pay
more for stocks. The S&P 500 index is trading at record highs
after gaining about 10% this year.
"Investors need to realize what they're paying a premium for,"
said Howard Silverblatt, senior index analyst at S&P Dow Jones
Indices.
In all, dozens of large companies bought back 4% or more of
their shares outstanding in the 12 months ended in June, according
to data from S&P Dow Jones Indices. The resulting boosts to
earnings might seem small in any given quarter, but they add up --
Apple's buybacks also added 8 cents a share in the March quarter,
for instance. And companies also have started big new buyback
programs, suggesting earnings-per-share increases will
continue.
The buybacks aren't necessarily done for the express purpose of
increasing per-share earnings. Many companies say they want to
return excess capital to shareholders. Others intend to offset new
shares issued to employees as compensation.
The per-share earnings increases generated by stock buybacks are
low quality, inflating results without underlying substance, said
Gregory Milano, chief executive of Fortuna Advisors, a financial
consulting firm that has examined buyback trends. "It has less
value."
Companies play down the buyback effect. They say their earnings
are strong even without buybacks, and that while the buybacks add
to per-share earnings, the effect is clear to investors and baked
into the analyst earnings estimates that drive stock prices.
Apple pointed to its past statements that its earnings growth is
accelerating and that tax reform "enables us to deploy our global
cash more efficiently," leading it to put forward plans to create
20,000 U.S. jobs and invest $350 billion in U.S. operations over
the next five years.
Union Pacific's buybacks contributed 9 cents to its
second-quarter per-share earnings, helping that metric to climb
37%, while net income rose 29% from a year ago. The railroad's
finance chief, Robert Knight, said the buybacks "represent the
return of excess cash to our shareholders and are consistent with
guidance we provided to the financial-analyst community."
Southwest Airlines' second-quarter net income excluding items
declined 2.1% from a year ago. On a per-share basis, however, it
rose 2.4%, in part because the company has repurchased 28.3 million
shares in the past year. Southwest said its per-share earnings
growth "has been driven primarily by the strong financial
performance of our robust network."
As the economic cycle grinds on, Mr. Milano said, companies may
find it harder to show earnings growth even as they face increased
pressure from shareholders to do so--"and so buybacks start to look
more attractive."
The buyback effect adds to the earnings boost companies are
already seeing because the U.S. cut its corporate tax rate to 21%
from 35%. Union Pacific's second-quarter effective rate, for
example, declined to 22.1% from 37.5% a year ago, before the tax
overhaul. At some companies, the tax cut has accounted for half or
more of reported profits.
The benefits to per-share earnings from buybacks can help a
company's result compare more favorably to Wall Street
forecasts.
In each of the past two quarters, big buybacks by Cisco Systems
Inc. increased its adjusted per-share earnings by 2 cents. Each
time, the networking giant's total results surpassed analysts'
consensus expectations by a penny.
Cisco said its buybacks are incorporated into the earnings per
share guidance it provides to analysts. "This is not a quality of
earnings issue, and it is inaccurate to state that we would have
otherwise 'missed' EPS targets," a company representative said.
Experts say when companies do guide analysts on their buyback
plans, the effect on estimates is imprecise. For instance, buybacks
earlier in a quarter make a bigger difference in per-share
earnings, because such results are calculated using average shares
outstanding. Companies, though, don't typically forecast the timing
of buybacks.
In the first quarter, just after the tax overhaul, a record 78%
of S&P 500 companies reported earnings above analysts'
expectations, according to FactSet. The second quarter then beat
that record, with 80%.
Write to Michael Rapoport at Michael.Rapoport@wsj.com and Theo
Francis at theo.francis@wsj.com
(END) Dow Jones Newswires
September 23, 2018 10:14 ET (14:14 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
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