Since the recession, stock buybacks have been a favorite of S&P 500 companies, with trillions of dollars being spent.
According to research by FT back in 2014, SPDR S&P 500 ETF Trust (SPY) companies spent well over 40% of their operating profits on stock buybacks in the five years that followed 2009. This has caused stocks to soar despite a very slow-growing U.S. economy.
What’s important is that companies have used cheap debt because of historically low interest rates to fund these big stock buybacks over the last seven years.
However, with interest rates starting to rise, many investors fear that stock buybacks will take a big step back in 2016, thereby putting pressure on stocks.
While the logic associated with this notion makes sense, truth is that 2016 will very likely be the strongest yet for stock buybacks.
Why Companies Will Buy Back More
Fact is that share repurchase plans for 2016 have already been established, and the funds raised to do so are largely in place.
Recently, Goldman Sachs estimated that 27% of the cash that companies spend in 2016 will be used for stock buybacks. That percentage is equal to what companies spent in 2015 and higher than the 25% in 2014. In total, SPY components will spend $608 billion this year on stock buybacks, even more than the $568 billion spent in last year’s zero rate environment.
Therefore, it may seem that an interest rate hike is bad for buybacks, but with a very small 25 basis point rise in interest rates, companies still see a great benefit in large share repurchase plans.
Three Classes of Buyback Stocks
With that said, there are three groups of stocks whose buybacks in 2016 could be a big catalyst.
First, there are companies that have been big spenders on buybacks over the last few years, who investors fear will cut buyback spending in 2016. The best example is Apple (AAPL), whose near-$40 billion in trailing 12-month spending on share repurchases is more than double the next closest buyback spender, Microsoft (MSFT) at $15.2 billion.
AAPL declined nearly 9% in the final month of 2015, and fears that buyback activity would diminish was likely one of many reasons for the fall. However, with Apple recently upping its buyback authorization by $50 billion to $140 billion, I think it is highly unlikely that AAPL is worried about a 25 basis point increase to interest rates. Not to mention, AAPL paid just $733 million in interest expenses throughout its last fiscal year.
On $56 billion in total debt, that’s an interest rate of 1.3%. Given that AAPL pays a 2% annual yield on all shares, the company actually saves money by retiring shares due to its low interest rate. Hence, don’t expect AAPL to slow buybacks any time soon, not with a measly 25 basis point rise in interest rates.
Second, there are companies that recently launched big buyback programs that have flown under the radar. For example, Nike (NKE) just launched a $12 billion buyback program to commence once the current $8 billion program ends. NKE is quite a bit lower since announcing the plan back in December. However, $12 billion is good for more than 11% of all NKE shares outstanding, and is proof that large companies still see buybacks as a good use of capital despite higher interest rates.
Third, there are companies that will launch big buyback programs this year, regardless of the interest rate hike. Alibaba (BABA) is one such company that will almost certainly launch an enormous share repurchase plan in the immediate future, and will use debt to finance it.
BABA launched a $4 billion buyback plan back in August that was supposed to be used over the course of two years. However, BABA spent nearly 70% of that $4 billion total in the two months following the buyback plan announcement.
Also during this time, BABA has traded higher, implying that a much larger program could follow in the near future.
What It Means for Stock Buybacks
The bottom line is that SPY companies don’t fear the Fed; they know that the Fed will be very conservative with all future interest rate boosts.
As a result, companies will continue to buy back stock with authority throughout 2016 and will launch large programs. Stocks that do so will outperform those that don’t.
In other words, it is still a good idea to invest in companies that see value in buying back the most stock.
As of this writing, Brian Nichols owned shares of AAPL and BABA.
