By Eric Bush, CFA - Gavekal Capital Blog
Much has been made about the stock buyback "craze" over the past several years. There is a common argument that says companies have been massively levering up in order to buy back their own stock, which, in turn, boosts EPS at the detriment of investing in the future or returning money to shareholders via dividends. However, when we look at the aggregate data for US companies ex-financials, we don't believe this argument holds up under scrutiny.
Before diving in, we want to introduce a new data series - what we refer to as aggregate data - to our readers that we will undoubtedly be referring back to quite a bit in the future. Our aggregate data is calculated very simply. We add up each individual financial line item (in USD) for each company in whatever subset of companies we are referring too. For example, in the analysis below, we are looking at the aggregate data for US companies excluding financials. So, to calculate operating cash flow, we sum each individual company's operating cash flow in order to produce an aggregate operating cash flow for the GKCI United States Index Ex-Financials.
Back to the supposed buyback craze argument. First of all, it is true that stock buybacks have increased from about $150 billion in 2010 to $510 billion as of February. However, the level of share repurchases has increased, because companies are producing ever more cash flow from each dollar of sales. Aggregate operating cash flow as of February is over $1.4 trillion, and operating cash flow as a percentage of sales is basically at a cycle high of 14.2%. Consequently, share repurchases as a percentage of operating cash flow currently stands at just 35%, which is significantly below the ratio we saw back in 2007-2008, when share repurchases as a percentage of OCF peaked around 48%.
So, if companies are squeezing out more operating cash flow for every dollar of sales and repurchases are below previous highs, what else are they spending it on? Well, companies are returning more of it to shareholders, as they have paid out about $325 billion in dividends - an amount that is about double what it was in 2006. In addition, companies are using their cash flow to buy up their competitors or suppliers, as acquisitions as acquisitions have greatly increased.
Okay, so more money is being returned to shareholders, and this has to come at the detriment of investments for the future (i.e., capex and R&D), right? Not exactly. Over $750 billion has been spent on capex, and capex as a percentage of sales is near a cycle high as well. Meanwhile, investments in R&D have more than doubled since 2004, and R&D as a percentage of sales is at its highest level since 2001. And keep in mind that all of this has occurred while cash as a percentage of total assets keeps rising!
Finally, what about debt? Yes, long-term debt has been increasing, but importantly, it is still below its 2003 highs. Short-term debt, however, has been structurally declining over the past 15 years, going from about 18% of total capital to just 6% of total capital. Therefore, total debt and net debt as a percent of capital are both well below highs made in 2003. This balance sheet data doesn't seem to support the notion that companies are borrowing a lot of money in order to buy back stock.
All in all, we don't understand all the fanfare surrounding stock buybacks. In fact, it seems that most of the attention has been inappropriately focused on absolute levels, making the common error of not looking at this data from a ratio perspective. Sure, the absolute level of stock buybacks has increased, but so has the level of dividends, acquisitions, R&D, and capex. And all of this makes sense, as companies are turning out more OCF from every dollar of sales than they ever have over the past 15 years.