I’m betting you’ve reined in your spending during the recent economic recession and continuing uncertainty plaguing global economies. Our household certainly has! But even with the reduction in consumer spending in the past few years, it’s a sad fact that most households have seen their net worth fall. According to the Federal Reserve, during the third quarter of this year, Americans saw their net worth decline about $2.4 trillion — primarily due to dropping values in our homes as well as in our investments.
But on the corporate front, things are much brighter …
As you’ve undoubtedly heard and read about, corporations have come out of the recession a lot better than households. They were smarter this time around — cutting costs very early, which has served them well. Corporate profits have been heading up for the past year and, according to Thomson Reuters, rose 17.9% in the third quarter.
And instead of rushing out to spend that extra money, America’s businesses have been hoarding their cash. Still rising — some 28% of assets now — corporate cash and equivalents stand at about $2.12 trillion, according to the Federal Reserve.
Traditionally, companies use their cash in five ways:
- Cash reserves
- Product/business expansion
- Mergers and acquisitions
While they are keeping their cash reserves high, companies have been very timid at business expansion in the past couple of years. We are beginning to see more money flowing into R&D, and M&A is picking up. There’s been about $2.22 trillion in transactions so far this year — roughly the same as 2010, according to Bloomberg, but we have yet to see a barn-burning run to build business.
Instead, companies in the S&P 500 Index have been putting their cash to use primarily in two ways:
- By increasing their dividends
- By rushing to buy back shares
So far this year, companies in the index have increased their dividends by about 10%, which has been a nice bit of extra change to many investors. But the buyback trend is much more pervasive.
In the second quarter of 2011, S&P 500 companies spent $109.2 billion buying back their shares — a rise of 21.6%, and the eighth consecutive quarterly increase in stock buybacks. Year-to-date, more than $454 billion in stock buybacks has been authorized — the most since the 2007 peak of repurchases, at $914 billion, according to Birinyi Associates. Companies buying back their shares this year include IBM (NYSE:IBM), Pfizer (NYSE:PFE), Dell (NASDAQ:DELL), Disney (NYSE:DIS), Lowe’s (NYSE:LOW), Coca-Cola (NYSE:KO), Goldman Sachs (NYSE:GS), DuPont (NYSE:DD), Navistar (NYSE:NAV), Intel (NASDAQ:INTC) and Amgen (NASDAQ:AMGN). Even Warren Buffett’s Berkshire Hathaway (NYSE:BRK.B, BRK.A) has jumped on the bandwagon.
Sounds good, doesn’t it? After all, by reducing the number of shares outstanding, the earnings of a company are distributed among fewer shares, so earnings per share effectively rise. And investors love it when earnings increase — no matter the cause — and often reward a company by sending its shares higher.
But astute investors need to look behind the scenes to determine if share buybacks are good for investors in the long run.