By Wallace Witkowski, MarketWatch
SAN FRANCISCO (MarketWatch) -- Corporate share buybacks, which
have risen to record amounts along with market highs, may begin to
lose their luster for investors as an earnings booster as the end
of cheap debt nears and fundamental growth gets more scrutiny.
Stocks sold off last Wednesday in reaction to a possible hike in
the near-zero fed funds rate in about a year's time. At a Federal
Open Market Committee news conference, Federal Reserve Chairwoman
Janet Yellen said rate hikes could begin "around six months" after
the Fed closes out its bond purchase program, which is expected to
end in about six months. That low rate of borrowing has encouraged
more corporate borrowing, which in turn has made it into dividends,
debt refinancing, and share buybacks.
On the week, the Dow Jones Industrial Average (DJI) finished up
1.5%, the S&P 500 index (SPX) closed up 1.4%, and the Nasdaq
Composite Index (RIXF) finished 0.8% higher, even though all three
indexes closed lower on Friday.
The amount spent on share buybacks in the past fourth quarter is
expected to reach a new high, according to an estimate from Howard
Silverblatt, senior index analyst at S&P Dow Jones Indices.
Verified figures are expected this week.
But those levels of spending aren't likely to continue.
Investors are becoming more likely to reward companies that are
increasing earnings and sales in tandem, and less likely to reward
companies that have been using buybacks for earnings support.
"People are starting to wise up: McDonalds and IBM have done
[buybacks] for years, but shares have stagnated," said Paul Nolte,
portfolio manager at Kingsview Asset Management. "People want to
see real earnings, real sales."
Share buybacks for S&P 500 companies are estimated to have
reached $129.39 billion for the fourth quarter on operating
earnings of $250.05 billion, according to S&P Dow Jones Indices
data.
Meanwhile, corporations are still issuing more than $200 billion
in debt a quarter, and have been doing so since the first quarter
of 2012, hitting a peak of $298.79 billion in the fourth quarter of
2012, according to data from Dealogic. At the beginning of 2012,
the benchmark 10-year Treasury note (10_YEAR) was yielding just
under 2% and fell as low as 1.39% that year, compared with the
current yield of 2.75%.
That record amount, however, appears to have purchased fewer
shares, said S&P's Silverblatt in emailed comments. With
S&P 500 companies spending $128.16 billion on share buybacks in
the third quarter, the S&P 500 index also rose 10% during the
fourth quarter. More telling from an earnings standpoint, companies
also appear to have issued fewer shares, resulting in lower share
counts and higher earnings per share, Silverblatt added.
Buybacks may have peaked, said Brian Belski, chief investment
strategist at BMO Capital Markets, but don't expect them to
disappear altogether seeing we're still a very long way from a 5%
fed rate. Buybacks will still be part of the earnings toolbox for
corporate executives, but investors are going to need to start
seeing both sales and earnings growing in tandem, he said.
Executives are still playing it conservatively by keeping
expectations low, and analysts are likely to play along, Belski
said.
That's apparent in the outlook for the coming earnings season.
First-quarter earnings are expected to be flat, down from an
estimated 4.4% growth rate back on Dec. 31, because of downward
revisions, according to John Butters, senior earnings analyst at
FactSet.
Profit warnings for the first quarter remain high with 84%
company earnings outlooks falling below the Wall Street consensus.
Tech and consumer discretionary companies make up a large number of
those negative earnings forecasts: 24 out of 32 tech companies are
guiding downward, along with 21 out of 23 consumer discretionary
companies guiding below the consensus.
A better metric of corporate optimism is reflected in dividend
actions, Belski said.
"We believe that companies increase dividend payments only if
they think things are going to get better in the future, given the
stigma associated with dividend cuts," Belski said in a recent
note.
A handful of companies report earnings this week including
Walgreen Co.(WAG), Carnival Corp.(CCL), Accenture PLC(ACN), Red Hat
Inc.(RHT), Paychex Inc.(PAYX), and GameStop Corp. (GME)
First-quarter earnings season won't be in full swing until
mid-April when J.P. Morgan Chase & Co. (JPM) reports.
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