Macroscope | Why stock buy-backs continue to drive growth in the US markets

Varun Ghotgalkar says corporate stock repurchases remain a popular way to return value to shareholders because they are not penalised by taxes, they can send signals about the stock’s value and are not subject to ‘sticky dividends’

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A trader at the New York Stock Exchange smiles as US stocks close higher on April 12. Stocks have enjoyed a bull run under the Trump administration and corporate stock buy-backs have been the major source of demand for American equities. Photo: Xinhua

Published: 10:57am, 2 May 2018Updated: 11:06pm, 2 May 2018

Stock repurchases by corporations have been by far the most dominant source of demand for American equities in the current bull market. Equity buy-backs for S&P 500 companies have exceeded US$3.5 trillion since the global financial crisis, and topped US$7 trillion since 2001.

The increasing use of stock repurchases to pay back equity investors (instead of dividend payments) has often been attributed to the decreasing cost of debt financing, driven by falling interest rates, regulatory changes involving stock buy-backs and the rise of equity-linked compensation for executives.

Buy-backs appear to be a strong tailwind for markets amid the volatile backdrop, while contributing to earnings-per-share growth. Buy-back announcements this year in the United States (as at the end of March 2018) are around 58 per cent higher, relative to the same period last year, despite concerns about the rising cost of capital, elevated leverage ratios and tightening credit market conditions as fundamentals remain solid – reflected by recent earnings trends.

The move to buy-backs is clearly observable in many sectors, especially technology and financial industries, but sectors like utilities and telecommunications are still mainly giving payouts in the form of dividends.

Buy-back operations, like dividend payments, are simply a way to return excess cash to shareholders. But why buy-backs?

First, an optimal debt equity mix for every company is found by weighing the costs and benefits of leverage, keeping assets and investment plans constant. Assuming stock repurchases are conducted with financial prudence, they can positively impact shareholder value by optimising capital structure.