According to Jessica Menton, writing in the Wall Street Journal,
“U.S. companies have been buying back their own shares at a blistering pace for more than a year, and market turbulence isn’t likely to stop them now.”
“The roughly 86% of firms in the S&P 500 that have reported results for the first quarter repurchased $188 billion worth of their own stock during that time, according to S&P Dow Jones Indices, on pace to be the second-highest amount on record based on data going back to 1998.”
This behavior is becoming so prevalent that we maybe need to ask the question, “is this a part of the new era of modern corporate performance?”
If it is, then investors, but also government policy makers, need to adjust their interpretations about how the world works.
And, who is leading the companies? Well, Apple (NASDAQ:AAPL), Oracle (NYSE:ORCL) and Cisco Systems (NASDAQ:CSCO) were the biggest buyers of their own stock in 2018, and repurchased a total of $126 billion of shares.
In April, Apple announced it would add $75 billion to its buyback program.
“We’re in the fortunate position of generating more cash than we need to run our business and invest confidently in our future,” Apple Chief Executive Tim Cook said during the company’s earnings call last month.
It's unfortunate that Apple is facing such a dire situation, but so are a lot of other organizations I would include in the category of the “new” Modern Corporation.
As I have written before, the “new” Modern Corporation thrives off of intellectual property and uses this intellectual property to build platforms and networks that can increase scale at zero or near-zero marginal costs. This means that the corporation can generate large bundles of profits and massive piles of cash.
And, for the “buyback game,” massive piles of cash are the norm.
This leads to another primary characteristic of the “new” Modern Corporation: They may be leaders in the creation and development of information technology, but they also are leaders in financial engineering. With all the cash flows they generate, they must be leaders in financial engineering in order to maximize their performance.
Big tech companies represent the paradigm of the “new” Modern Corporation, and with Apple, Oracle, and Cisco Systems leading the pack in stock buybacks, we see statistical support for the claim that financial engineering was a major part of what these organizations did.
Ms. Menton writes,
“Last year, the top 20 companies repurchasing stock in the S&P 500 - many of which were tech firms — accounted for 42% of all buybacks, compared with a 32% share in 2017, data from S&P Dow Jones Indices showed.”
Furthermore, the data also showed that in the fourth quarter of 2018, technology companies bought back 28 percent of all repurchases recorded for S&P 500 companies.
But, corporations, other than just big tech, have followed their lead, and have moved toward becoming a part of the “new” Modern Corporation paradigm. These other corporations are focusing on intellectual property, on building platforms and networks, and of generating lots and lots of profits and cash. I have written and spoken on this topic regularly.
The financial data on these firms show that they usually produce a high return on shareholder’s equity, with many turning in results in the 15 percent to 20 percent or more, range.
Second, these organizations earn this return with very little longer-term debt on their balance sheets. Note, that in the past, financial leverage was used to “pump up” the return on equity. The “new” Modern Corporation does not need “to be goosed” in that way to earn the returns that they do.
Third, the “new” Modern Corporation does not need to draw more financial capital to their balance sheet. They are primarily “equity” institutions and, in fact, use their cash buybacks to keep price-earnings ratios high, thereby giving more incentive to investors to bid up their stock price.
Furthermore, generating all this cash allows the “new” Modern Corporation to set aside funds for research and development and the purchase of physical capital without any reliance on capital markets to fund them. In addition, they have the funds to go out and buy technology from startups or early stage companies and build their intellectual capital, externally as well as internally.
Thus, these companies are not as subject to swings in financial markets or efforts by the government to stimulate or restrict economic growth.
These companies have the cash on hand to do almost everything they want to do, at almost anytime they want to do it. Screw government economic policymaking.
Ms. Menton writes,
“Every quarter in 2018 marked a new high for buybacks, as companies were bolstered with money they saved because of corporate tax cuts.”
“The most buybacks in one quarter, a staggering $223 billion, came in the last three months of last year when broader markets spiraled. Buybacks also hit a record in the first quarter of 2018 when markets sold off.”
Thus, market corrections play into the game because it means that the existing cache of cash held by a corporation can obtain more shares.
This type of corporate behavior is growing. New management teams are being brought in to manage “legacy” companies and make them into “new” Modern Corporations,. This, to me, is the future. It's also a sign of the technology that underlies modern business operations.
One investment strategy might be to just look at the corporations that are buying back their stock. Once these companies are identified, check out to see where they stand relative to the model of the “new” Modern Corporation. Then judge whether or not the leadership of the organization is capable carrying out this evolutionary business model. Here you might check the return on shareholder’s equity and see whether or not the company has a sustainable competitive advantage or is creating one. But this is not a short-run strategy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.