‘Go Figure!’ SocGen Reveals The Ugly Truth About The Buyback Bonanza

Andrew Lapthorne has been on a veritable crusade to expose companies engaged in what the SocGen strategist has variously described as activity that’s “clearly nonsense.”

The “clearly nonsensical” behavior he so despises is the practice of leveraging the balance sheet to infinity on the way to buying back already inflated shares.

Here’s the key excerpt from a note out earlier this year:

As we have long pointed out, the reason for [the] increase in debt is largely down to financial engineering — aka share buybacks. Borrowing money to buy back your elevated shares is clearly nonsense.

This is of course part and parcel of the central bank-inspired hunt for yield. Policymakers drive down rates, sending investors scurrying for any semblance of yield, and that artificial demand is met with increased corporate supply, the proceeds from which are plowed into bottom-line/management compensation-inflating buybacks.

So that’s the scheme. And on Thursday, Lapthorne is back with an expansive look at this dynamic and it’s dripping with cynicism and disdain which means it’s all kinds of fun.

First of all, Lapthorne really needs you to understand what Goldman has been telling you for sometime – namely that the key source of equity demand in the US is the corporate bid. To wit:

US share buybacks have been a key mechanism by which central bank quantitative easing has had a direct influence on US equity prices. Whilst investors for one reason or another have been reducing their exposure to US equities, corporations via share repurchasing have been taking up the slack. The result is just over US$3trn of gross and US$2.2trn of net share buybacks over the past six years, which equates to around 17.5% of the total market capitalisation of the US equity market, and which has provided a significant support mechanism for US equities over the period.

Having dispensed with the necessaries, Andrew moves on to reveal something that probably should be intuitive, but is nevertheless lost on some folks:

Another misconception is that buybacks (or at least buyback indices) are typically all about growth stocks. We tend to associate share repurchases with large cash-rich tech companies. This however is not really correct, buyback indices (i.e. stocks that do a high level of share repurchases) tend to have more in common with Value factors and tend to be negatively correlated to companies with strong balance sheets, higher levels of profitability (ROE, ROA, GPOA etc.), and to our growth measures (i.e. those stocks that have exhibited the strongest historical growth over the past three years and those with the strongest forecast growth). Buybacks are then a sign of financial weakness, and not strength, as is typically thought to be the case.

He takes it a step further by looking at the correlation between companies buying back shares and a series of other factors, and the conclusion is the same:

We can conclude that typically the company doing a share buyback over the past 12 months has been a value stock, with higher share price volatility, a below average dividend yield, it is smaller than the average company (within our FTSE US universe), it has below average 12 month price performance, and it is highly correlated with companies with the worst balance sheets — go figure!

Yes, “go figure!”

Next, Lapthorne draws on some of the extant literature to remind you that in many cases it’s the announcement, not the actual buyback that matters and then, he “throws the kitchen at” the analysis in search of evidence to support the contention that buybacks help the shares of the companies doing the repurchasing and comes up empty:

We have measured the coincident performance of companies that buyback their shares and we can pretty much conclude that there is no performance advantage whatsoever during the period they buy back their share. We have looked at this in a variety of formats. We have looked at quarterly and annual share buybacks versus quarterly and annual share price performance. We have analysed this on an absolute, industry and sector relative basis. We have looked at average performance, sector relative performance, normalised performance. We have essentially thrown the back-testing kitchen sink at it and cannot find anything to suggest that doing a share buyback positively affects the share price of a company.

There’s much (much) more in the full note, but ultimately, the conclusion is that while buybacks help support the broad market, they do not generally help prop up the shares of the companies doing them and as it turns out, those companies tend to be pieces of shit – on balance (obviously Andrew doesn’t put it quite like that, but it’s close).

This is not to say that buybacks have not benefitted the equity market overall. If your shares are bought off you, then you typically need to reinvest them, and we estimate that the US has had 17.5% of its market cap bought back over the past 6 years.

Ironically, given that buybacks are usually done by below average quality companies, this may also provide investors with an excuse for an exit. The proceeds may be recycled into a better performing asset. Buybacks may boost the market, but they do not obviously benefit those companies doing it.

Here’s Lapthorne’s hilariously sarcastic summary of where we find ourselves:

Any reader of our research will be aware of our dislike for share buybacks, particularly those funded by debt. We have a strong preference for the more visible and dependable humble dividend. But in the US a decent dividend yield seems to be more a measure of a company’s failing growth prospects than a just reward to the shareholder. Moreover with executive pay based on EPS growth and share price performance, and that pay coming in the form of stock options (themselves offset by buybacks), we doubt, sadly, that buybacks are going away anytime soon. This is a big shame given demographics suggest a continuing long-term demand for sensible yielding investments and just perhaps if companies offered more dividend yield, investors would sell less… just a thought….

“Go figure.”

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