US companies have announced more than half a trillion dollars in mergers and acquisitions alone this year. In the short term, all this deal making has the effect of lifting the entire stock market as every company rushes to get in on the action-every company becomes a potential acquisition target.
But, over the long term, studies show that mergers and acquisitions destroy shareholders value particularly those done when stock prices are at or near their peak as they are now. Instead of investing in new plants, equipment and products, instead of paying their taxes and giving employees a long overdue raise, big corporations are spending their profits and gobs of newly borrowed money to buy back their own shares and those of other companies.
Meanwhile, the corporations of the S&P 500 spent $477B buying back their own shares, which is the most since the peak year of 2007. The concept behind buybacks is that they are a tax advantaged way to return profits to shareholders by boosting the market price of shares. Since the stock market tends to value companies, by multiplying profits per share, times the number of shares, reducing the number of outstanding shares has the arithmetic effect of boosting the stock price.
Buying back shares is so prevalent, that 80% of the S&P companies participated since last year. Among the most aggressive, have been Boeing, Caterpillar, Cisco, 3M, Microsoft, Safeway and Travelers who all bought back more than 10% of their shares over the last year. Apple alone has announced it would spend $130B to repurchase their shares, and two weeks ago even Ford Motor joined the parade with an $18B buyback announcement.
Make no mistake-in the short term the buyback strategy works. Stock buybacks in the S&P500 transformed what would have been an 80% rebound from the lows of 2009, into a 170% increase according to a study by Fortuna Advisors. It would be one thing if most of these stock buybacks were paid for out of the trillions of dollars in cash now sitting on corporate balance sheets.
But as it happens, most of them have been paid for by near record levels of corporate borrowing. Of the $3.4T dollars of additional debt taken on by non-financial corporations since 2009, almost 90% has been sent to shareholders in the form of dividend and share buybacks.
On the surface, investors may view this as a good thing; but if you are still holding the stock, you now have a liability in the form of the debt on the balance sheet where previously you had an asset with free cash only and no liability. This liability exceeds cash assets three to one. In short, what is missing from the current recovery is all the money that corporate America has bled off on financial game playing.
That money could have been used to invest in equipment and products and put extra money in the pockets of consumers and that would have provided tax money to governments which then could have invested in basic infrastructure, research and the education of the next generation of workers.
US markets are still basically flat this year despite the gyrations. The yield curve is still flattening with a 180 basis point difference in the 5 yr. to 30 yr.- at the beginning of the year that difference was 270 basis points.
DISCLOSURE: Opinions and estimates offered constitute the judgment of MCS and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
This article was written by Metropolitan Capital Strategies CEO Sharon Snow and Chief Investment Officer David Schombert.