Gamable EPS And Share Buybacks

by: Constantin Gurdgiev

EPS (Earnings per Share) is a corporate metric that is often pursued by the corporate managers and executives to increase their own payouts, and confused by investors for a signal of company health. As is well known (and we show this in our Risk & Resilience course), EPS is a "gamable" metric - in other words, it can be easily manipulated by companies, often at the expense of actual balance sheet quality.

And I have written about this problem here on the blog for ages now.

So, here is a fresh chart from the Deutsche Bank Research (via @bySamRo) detailing share buybacks' (repurchases) contribution to EPS growth:

In basic terms, there is no organic EPS growth (from net income) over the last 7 quarters, on average, and there is negative EPS growth from organic sources over the last 4 consecutive quarters.

As noted in my lecture on the subject of "EPS gaming", there are some market-structure reasons for this development (basically, rise of tech-based services in the economy):

Click to enlarge

Source of Data: McKinsey

Click to enlarge

Source: McKinsey

However, as the chart above shows, share buybacks simply do not add any value to the total returns to shareholders (TRS), and that is before we consider a shift in current buybacks trends toward debt-funded repurchases. So, in a sense, current buybacks are rising leverage risks without increasing TRS. Which is brutally ugly for companies' balance sheets, and given debt covenants, is also bad news for future capex funding capacity.