The S&P 500 set another record high on Tuesday and U.S. companies buying back their own shares at a furious pace seems to have helped fuel the rise in stocks. But should investors be worried about too much of a good thing?
During the fourth quarter of 2013, companies in the S&P 500 boosted the amount they spent on share repurchases by more than 30% from the year-ago period. Buying back stock can raise earnings per share when the total number of shares outstanding decreases. In other words, investors are left with a larger slice of the overall profit pie.
In 2013, the sum of all S&P 500 company buybacks was $477.6 billion, up nearly 24% from the previous year, according to FactSet.
Investment strategies that specialize in share buybacks and dividends performed well last year, and the trend seems to be holding up reasonably well in early 2014. However, some high-profile investors are concerned that the preoccupation with returning capital to investors after the financial crisis may be promoting a dangerous focus on the short term.
For example, BlackRock CEO Larry Fink has expressed concerns that companies are emphasizing dividends and stock repurchases at the expense of future growth, Reuters reports.
They may be starting to heed his advice. It appears that U.S. companies scaled back their share repurchases in the first quarter of 2014, even though several banks announced stock buybacks after passing the Federal Reserve’s latest round of stress tests.
Jason Zweig at WSJ.com writes that last year’s surge in share buybcks could be contributing to an overvaluation of the U.S. stock market.
Interestingly, companies don’t have a good track record in recent years with timing their share repurchases. In 2007, they loaded up on buybacks right before the financial crisis, then pulled back in 2008 and 2009 when their shares appeared cheap.
“If share repurchases consume too much of companies’ excess profits, the underlying businesses might end up starved, which could lower future returns,” Zweig wrote. “So the surge in buybacks is worth watching closely. If companies end up chasing their own shares as high as they did in 2007, a fall to earth might not be far behind.”
Photo Credit: Thomas Hawk via Flickr Creative Commons
DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. All investments involve risk, the amount of which may vary significantly. Dividends reflect past performance and there is no guarantee they will continue to be paid. Share buyback programs are typically temporary and should not be relied upon in the long term. Past performance is no guarantee of future results.
