Stock Buybacks and the Truth About Earnings

Corporate stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. buybacks are the media’s current Wall Street whipping boy, and pundits often claim that the sole purpose of a buyback is to inflate earnings per share (EPS) and prop up the stock market. Criticism has become particularly heated recently as companies repurchased more than $1 trillion in stock over the past two years. Apple, for one, has committed to billions of dollars in dividends and buybacks in an attempt to whittle down its copious cash reserves.

But a hard look at the data suggests the media is getting buybacks all wrong: During the stock market’s recent rise, buybacks have had little impact on EPS, and aren’t doing much to prop up the overall market.

Let’s take that earnings-per-share argument first by looking at the “buyback effect.”

To get a measure of the impact of stock buybacks on the S&P 500, we can compare total earnings growth for companies in the index with their earnings-per-share growth. Normally, these two numbers should be the same. The only way that overall earnings growth rates and EPS growth rates can differ is if the number of outstanding shares changes. If a company’s earnings are flat from one year to the next, but it buys back shares over the course of that year, then earnings per share will increase—not because the company earned more money but simply because of the reduction in the number of shares.

So, is this buyback effect providing a big boost to corporate bottom lines?

No. In aggregate, the buyback effect was small—on average just 1.4% from the beginning of 2017 through the end of 2018. Over the past two years, when companies purchased over $1 trillion of their own shares, buybacks increased EPS growth by less than 1.5%. On a quarterly basis, as the graph below shows, the “buyback effect” only boosted earnings per share by between 0.9% and 2.0%. At best, even during the market’s recent steep climb, buybacks were a mere wisp of a tailwind, not a major driver of EPS growth.

If stock buybacks aren’t major drivers of EPS growth, is it credible that they are propping up the stock market? If they were, then one might expect that the companies buying back their stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. would outperform peers that aren’t buying back stock. But this is not the case. While the S&P 500 returned 8.0% over the last 12 months through July, the S&P 500 buyback index, a measure of the performance of all companies engaged in buybacks, gained 5.9%.

Our analysts don’t believe it’s a valid argument to criticize buybacks for unrealistically boosting earnings per share or for somehow propping up the stock market. Their impact has been negligible. If you’d like to read more on the misconceptions and realities of buybacks, download a copy of Stock Buybacks: Public Enemy Number One?, or contact us at (800) 492-6868. We’re always happy to help you think it through.