With the stock market tumbling again, it’s bargain-hunting time. Companies buying back their stocks better make sure that they’re not throwing good money after bad.
Despite the S&P 500’s 18% drop this year, corporations continue to buy back their shares, or announce plans to do so. Most recently, AmerisourceBergen (ticker: ABC) announced a $1 billion buyback plan on June 1, while Broadcom (AVGO) announced a $10 billion plan on May 26, and Nvidia (NVDA) increased its plan to $15 billion on May 23. In fact, more than $300 billion of share repurchases have been announced over the past three months, according to Deutsche Bank data.
But buying back stock at the wrong time can be painful. Target (TGT), for instance, appears to have bought back 8.9 million shares at an average price of $225. The stock is now trading near $152—down nearly a third—after the company issued two profit warnings in recent weeks, resulting in an unrealized loss of about $650 million.
Despite the timing risks, buybacks are popular with both investors and executives. Chief financial officers like them because it’s a way to return cash to shareholders while having the flexibility to pause that doesn’t come with dividends, which are paid every quarter and are usually considered sacrosanct. For investors, buybacks reduce the number of shares outstanding, which means they get a larger piece of the profits for each share they own. They also like them because, combined with dividends, they help tamp down volatility in a stock, notes Evercore ISI strategist Julian Emanuel, who observes that “2022 is one of those years where investors are paid to focus on return of capital rather than return on capital.”
For much of the period following the financial crisis, companies borrowed money to buy back stock, taking advantage of ultralow interest rates to take shares off the market. Now, though, rates are rising—the two-year Treasury yield is at its highest level since 2007—and borrowing to buy back stock makes less sense.
That hasn’t prevented companies from buying back their shares. Instead of borrowing, they’re using the money they have on hand to do it. Barclays strategist Maneesh Deshpande puts corporate cash burn at about $70 billion a quarter, with most of the money getting put into buybacks. Excess cash, meanwhile, has fallen to about $300 billion from $500 billion, with the biggest drops coming in industrials, consumer-discretionary stocks, and the Fanmags: Meta Platforms (META), Amazon.com (AMZN), Netflix (NFLX), Microsoft (MSFT), Apple (AAPL), and Alphabet (GOOGL). If the market finds a floor, it would be money well spent. But that cash would come in handy if the U.S. were to fall into recession, something that would hit cash flow hard.
“We find the decline in excess cash…while increasing buybacks, surprising, as companies are seemingly unworried about economic volatility or tightening financial conditions,” Deshpande writes. “If the pace of cash drawdown continues, it would imply that tighter financial conditions will be even more of a headwind than we have previously assumed.”
His advice: Focus on companies that don’t need to spend too much of their excess cash in order to return it to shareholders, while remaining cautious on those that are burning through it too quickly. To do so, he projected the past two quarters worth of cash reduction over the rest of 2022 and then calculated a company’s projected cash-to-assets ratio.
Among those that look attractive following this exercise: Las Vegas Sands (LVS), which is sitting on a pile of cash after selling its Vegas properties; industrial company Emerson Electric (EMR); fertilizer company CF Industries Holdings (CF); and Vertex Pharmaceuticals (VRTX), which was a pick in this space in January. Las Vegas Sands and Emerson have dropped 11% and 6.3%, respectively, in 2022, while CF has gained 25% and Vertex is up 16%.
Cash burners include credit-reporting company Equifax (EFX), which has dropped 37% this year; Martin Marietta Materials (MLM), which has declined 27%; power infrastructure company Quanta Services (PWR), which has gained 8.8%; and content-delivery company Akamai Technologies (AKAM), which has fallen 17%.
Sometimes cash really is king.
Write to Ben Levisohn at Ben.Levisohn@barrons.com