Companies Buy Earnings Gains by Buying Back Stock
Tax cut-fueled repurchases are boosting per-share profits from Apple to Union Pacific and lifting the stock market to new heights
Companies’ record stock repurchases this year are causing profits to appear stronger and fueling the stock market’s record run.
A key driver in the surge of stock buybacks was last December’s tax overhaul, which lowered companies’ tax bills and freed up funds that many companies are using for share repurchases.
S&P 500 companies bought back a record $189 billion of their own shares in the first quarter, and a similar number—if not more—is expected for the second quarter, according S&P Dow Jones Indices. By contrast, S&P 500 buybacks totaled no more than $137 billion in any of the six quarters before the tax overhaul.
Stock buybacks make profits appear better by boosting per-share earnings, a metric that investors frequently use to justify a company’s stock price. Buybacks reduce a company’s share count, spreading the profits across fewer shares. As a result, companies can report a bigger percentage increase in per-share earnings than the profit results alone may show.
Among the more aggressive companies in buying back stock, Apple Inc. AAPL -1.08% repurchased 112.8 million shares in the quarter that ended in June, contributing 5 cents to its earnings of $2.34 a share. Union Pacific Corp. UNP 0.60% repurchased about 4% of its shares in the second quarter, helping earnings per share climb substantially faster than net income. Thanks to buybacks, Southwest Airlines Co.’s quarterly per-share earnings rose even though its profit fell from a year earlier.
For the S&P 500, per-share earnings in the second quarter rose about 25% from a year ago—a full 2 percentage points faster than net income, according to data from Thomson Reuters. “It would be fair to assume it is all from buybacks,” said David Aurelio, senior research analyst at Thomson Reuters.
The higher per-share earnings have helped lead investors to pay more for stocks. The S&P 500 index is trading at record highs after gaining about 10% this year.
“Investors need to realize what they’re paying a premium for,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
In all, dozens of large companies bought back 4% or more of their shares outstanding in the 12 months ended in June, according to data from S&P Dow Jones Indices. The resulting boosts to earnings might seem small in any given quarter, but they add up—Apple’s buybacks also added 8 cents a share in the March quarter, for instance. And companies also have started big new buyback programs, suggesting earnings-per-share increases will continue.
The buybacks aren’t necessarily done for the express purpose of increasing per-share earnings. Many companies say they want to return excess capital to shareholders. Others intend to offset new shares issued to employees as compensation.
The per-share earnings increases generated by stock buybacks are low quality, inflating results without underlying substance, said Gregory Milano, chief executive of Fortuna Advisors, a financial consulting firm that has examined buyback trends. “It has less value.”
Companies play down the buyback effect. They say their earnings are strong even without buybacks, and that while the buybacks add to per-share earnings, the effect is clear to investors and baked into the analyst earnings estimates that drive stock prices.
Apple pointed to its past statements that its earnings growth is accelerating and that tax reform “enables us to deploy our global cash more efficiently,” leading it to put forward plans to create 20,000 U.S. jobs and invest $350 billion in U.S. operations over the next five years.
Union Pacific’s buybacks contributed 9 cents to its second-quarter per-share earnings, helping that metric to climb 37%, while net income rose 29% from a year ago. The railroad’s finance chief, Robert Knight, said the buybacks “represent the return of excess cash to our shareholders and are consistent with guidance we provided to the financial-analyst community.”
Southwest Airlines’ second-quarter net income excluding items declined 2.1% from a year ago. On a per-share basis, however, it rose 2.4%, in part because the company has repurchased 28.3 million shares in the past year. Southwest said its per-share earnings growth “has been driven primarily by the strong financial performance of our robust network.”
As the economic cycle grinds on, Mr. Milano said, companies may find it harder to show earnings growth even as they face increased pressure from shareholders to do so--“and so buybacks start to look more attractive.”
The buyback effect adds to the earnings boost companies are already seeing because the U.S. cut its corporate tax rate to 21% from 35%. Union Pacific’s second-quarter effective rate, for example, declined to 22.1% from 37.5% a year ago, before the tax overhaul. At some companies, the tax cut has accounted for half or more of reported profits.
The benefits to per-share earnings from buybacks can help a company’s result compare more favorably to Wall Street forecasts.
In each of the past two quarters, big buybacks by Cisco Systems Inc. increased its adjusted per-share earnings by 2 cents. Each time, the networking giant’s total results surpassed analysts’ consensus expectations by a penny.
Cisco said its buybacks are incorporated into the earnings per share guidance it provides to analysts. “This is not a quality of earnings issue, and it is inaccurate to state that we would have otherwise ’missed’ EPS targets,” a company representative said.
Experts say when companies do guide analysts on their buyback plans, the effect on estimates is imprecise. For instance, buybacks earlier in a quarter make a bigger difference in per-share earnings, because such results are calculated using average shares outstanding. Companies, though, don’t typically forecast the timing of buybacks.
In the first quarter, just after the tax overhaul, a record 78% of S&P 500 companies reported earnings above analysts’ expectations, according to FactSet. The second quarter then beat that record, with 80%.