In every bubble there are trends so obviously crazy that it's hard to see
how anyone, let alone mainstream money managers, can buy in. And yet buy in
they do.
This time around there are almost too many such trends to count. But perhaps
the most obvious is corporate share repurchases. Though already a well-known
and much lamented practice, it has yet to send hot money running for the
exits or spawn a regulatory backlash. But it has generated some good analysis
from mainstream news organizations, which might be a sign that we're near the
end. Consider this from Reuters:
When Carly Fiorina started at Hewlett-Packard Co in July 1999, one of her first
acts as chief executive officer was to start buying back the company's shares.
By the time she was ousted in 2005, HP had snapped up $14 billion of its stock,
more than its $12 billion in profits during that time.
Her successor, Mark Hurd, spent even more on buybacks during his five years
in charge - $43 billion, compared to profits of $36 billion. Following him,
Leo Apotheker bought back $10 billion in shares before his 11-month tenure
ended in 2011.
The three CEOs, over the span of a dozen years, followed a strategy that
has become the norm for many big companies during the past two decades: large
stock buybacks to make use of cash, coupled with acquisitions to lift revenue.
All those buybacks put lots of money in the hands of shareholders. How well
they served HP in the long term isn't clear. HP hasn't had a blockbuster
product in years. It has been slow to make a mark in more profitable software
and services businesses. In its core businesses, revenue and margins have
been contracting.
HP's troubles reflect rapid shifts in the global marketplace that pressure
most large companies. But six years into the current expansion, a growing
chorus of critics argues that the ability of HP and companies like it to
respond to those shifts is being hindered by billions of dollars in buybacks.
These financial maneuvers, they argue, cannibalize innovation, slow growth,
worsen income inequality and harm U.S. competitiveness.
A Reuters analysis shows that many companies are barreling down the same
road, spending on share repurchases at a far faster pace than they are investing
in long-term growth through research and development and other forms of capital
spending.
Almost 60 percent of the 3,297 publicly traded non-financial U.S. companies
Reuters examined have bought back their shares since 2010. In fiscal 2014,
spending on buybacks and dividends surpassed the companies' combined net
income for the first time outside of a recessionary period, and continued
to climb for the 613 companies that have already reported for fiscal 2015.
In the most recent reporting year, share purchases reached a record $520
billion. Throw in the most recent year's $365 billion in dividends, and the
total amount returned to shareholders reaches $885 billion, more than the
companies' combined net income of $847 billion.
The analysis shows that spending on buybacks and dividends has surged relative
to investment in the business. Among the 1,900 companies that have repurchased
their shares since 2010, buybacks and dividends amounted to 113 percent of
their capital spending, compared with 60 percent in 2000 and 38 percent in
1990.
And among the approximately 1,000 firms that buy back shares and report
R&D spending, the proportion of net income spent on innovation has averaged
less than 50 percent since 2009, increasing to 56 percent only in the most
recent year as net income fell. It had been over 60 percent during the 1990s.
Share repurchases are part of what economists describe as the increasing "financialization" of
the U.S. corporate sector, whereby investment in financial instruments increasingly
crowds out other types of investment.
The phenomenon is the result of several converging forces: pressure from
activist shareholders; executive compensation programs that tie pay to per-share
earnings and share prices that buybacks can boost; increased global competition;
and fear of making long-term bets on products and services that may not pay
off.
It now pervades the thinking in the executive suites of some of the most
legendary U.S. innovators.
IBM Corp has spent $125 billion on buybacks since 2005, and $32 billion
on dividends, more than its $111 billion in capital spending and R&D
during the same period. Pharmaceuticals maker Pfizer Inc spent $139 billion
on buybacks and dividends in the past decade, compared to $82 billion on
R&D and $18 billion in capital spending. 3M Co, creator of the Post-it
Note and Scotch Tape, spent $48 billion on buybacks and dividends, compared
to $16 billion on R&D and $14 billion in capital spending.
At Thomson Reuters Corp, owner of Reuters News, capital spending last year
totaled $968 million, more than half of which went toward R&D, according
to the company's annual report. Buybacks and dividends for the year were
more than double that figure, at a combined $2.05 billion. The company had
53,000 full-time employees last year, down from 60,500 in 2011. So far this
year, capital spending is at $743 million, while buybacks and dividends total
$2.02 billion.
In effect, these companies have become hedge funds, taking in cash and betting
it on movements in share prices. But because the portfolio managers (i.e.,
the CEO and CFO) are paid according to the shortest of short-term metrics --
year-end share price and dividend yield -- they couldn't care less about the
kind of company they're leaving to their successors a decade hence.
That pretty much sums up the "financialization" trend in business management
(and government and personal finance). And it virtually guarantees a bad outcome
at some point in the not too distant future.
