By William L. Watts, MarketWatch
NEW YORK (MarketWatch) -- Stock buybacks have been a popular way
for companies to return cash to shareholders, but the practice may
soon fall out of style.
Buybacks rose to $129.4 billion in the fourth-quarter of 2013,
according to S&P Dow Jones Indices, a 1% rise from the previous
quarter, while full-year 2013 buybacks among S&P 500 companies
rose 19.2% to $475.6 billion. The high-water mark was achieved in
2007, when companies spent $589.1 billion, according to the data
firm.
First-quarter data hasn't been finalized yet, but it looks like
buybacks continued at a heavy pace in the first three months of the
year, analysts say. Corporations, meanwhile, have been the biggest
buyers of stocks over the course of the record-setting bull
rally.
Increased buybacks are a rational response in an environment
where economic growth has long been stalled, with little impetus
from either government or consumer spending, said Joe Costigan,
director of equity research at Pennsylvania-based Bryn Mawr Trust,
which has $7.4 billion in total assets.
In such a low-growth environment, the last thing a company wants
to do is create additional capacity.
"Corporations are confronted by this and there are two things
that they know: If they buy assets outside of their industry,
they're probably not going to get the returns they need to justify
their purchase. If they buy their own assets back via share
repurchases, it's more of a known quantity," he said in a phone
interview.
Steven Ricchiuto, chief economist at Mizuho Securities, argued
in a note earlier this month that return expectations have moved
"out of alignment with reality."
Corporate managers are seeking out investments that meet their
"double-digit hurdle rate" while investors are also seeking out
above-market returns.
"This mismatch has dampened corporate investment spending, and
with limited top-line revenue growth, companies have remained
focused on cost cutting, share buybacks and dividend increases to
maximize shareholder value," he wrote. At the same time, companies
face pressure from activist shareholders demanding higher returns
even though market rates have plummeted as the inflation rate has
slowed.
Diminishing rewards
Some stock watchers question whether the buyback trend is likely
to continue at a rapid pace.
Investors have been less willing to reward buybacks recently.
The S&P 500 Buyback Index, which tracks the 100 stocks with the
highest buyback ratios, has a year-to-date return of 4.6%, lagging
a 5.4% return for the S&P 500 (SPX).
The buyback index returned more than 40% in 2013, according to
The Wall Street Journal, versus the S&P 500's 30% return.
Skeptics contend that the weaker outperformance indicates
buybacks are starting to lose their punch.
John Higgins, market economist at Capital Economics in London,
is one of those skeptics. He has laid out theoretical reasons why
debt-financed buybacks shouldn't provide much of a boost to share
prices even allowing for the tax deductibility of interest
expenses.
In a 2011 note, Higgins said the additional riskiness "brought
about by a share buyback should result in an increase in investors'
required return on equity that -- tax effects aside -- offsets the
company's increased return on equity."
More recently, he warned: "The U.S. stock market may lose an
important prop."
There's also the risk of overpaying. Buybacks peaked in 2007
just before the market collapsed.
In the end, a return to sustainable growth and higher yields
will likely start to slow buybacks, Costigan said. Rational boards
will stop buying back shares when they can use capital in more
productive ways, whether that's buying other company's shares,
improving the productivity of their own asset base or paying a
dividend, he said.
Week ahead: Fed meeting
This week's economic calendar is dominated by the Federal
Reserve meeting that concludes Wednesday and is followed by a news
conference by Fed Chairwoman Janet Yellen.
While Bank of England Gov. Mark Carney last week got investors'
attention by warning that U.K. interest rates may start to rise
sooner than market participants have penciled in, economists at RBC
Capital Economics expect the Fed to remain focused on soothing
concerns over the timing of the Fed's first rate hike.
Investors will undoubtedly keep an eye on developments in Iraq
after Sunni militias swept through northern cities and set their
sights on Baghdad, putting pressure on U.S. President Barack Obama
to authorize military intervention to aid Iraq's government. So
far, Iraq's southern oilfields are seen as safe, but the potential
for any disruptions could send oil prices spiking further, analysts
said. See: 5 things you need to know about Iraq.
On the corporate front, earnings are due from software maker
Adobe Systems Inc. (ADBE) on Tuesday, while package-delivery firm
FedEx Corp. (FDX) is due to report on Wednesday. BlackBerry Ltd.
(RIMM) and Oracle Corp. (ORCL) are slated to report Thursday.
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