As dividends and stock buybacks reach their highest levels since 2007, criticism of corporate efforts to return cash to shareholders is emerging. Skeptics contend that the announcements are designed to boost earnings per share and stock prices, and that money would be better spent on business reinvestment and hiring new workers.

My view is that much of this criticism is misplaced. Rather than an attempt to boost earnings per share, I believe the efforts to return cash to shareholders are an outgrowth of an uneven US economic recovery and accommodative monetary policy, and that corporations are continuing to reinvest in their own businesses at a healthy rate.

The buyback binge

At the end of the second quarter, 75% of all companies in the S&P 500® bought back shares and paid dividends in the trailing 12 months, according to data from FactSet, while $555.5 billion was spent on share repurchases in the same period.1 We’ve seen a steady stream of large, well-known companies such as AIG, Wendy’s and Apple announce buybacks, garnering a lot of media attention. Politicians have questioned whether companies are favoring buybacks over building new factories or giving raises to workers. As a result of this activity, by the end of June more than 20% of S&P 500 companies had reduced their share count by at least 4% year-over-year in each of the last six quarters.2

One of the factors driving the buyback trend is the incredibly accommodative monetary policy environment we’ve been in since 2008. Companies are taking advantage of the fact that the Federal Reserve has kept interest rates near zero to borrow money to buy back shares.

Record corporate profits are also driving buybacks. Corporate profits are at an all-time high, having increased for the past six years.3 Rather than keeping cash on their balance sheet, where low interest rates mean it doesn’t have the potential to generate much in the way of returns, corporations are putting the cash to work by repurchasing shares and returning money to shareholders.

It is true that buybacks help boost a company’s earnings per share (EPS) on a nominal basis. However, they are not the sole driver of record corporate profitability, especially when it comes to the S&P 500 Index.

According to S&P Dow Jones Indices, buybacks do not increase the EPS of the S&P 500 Index due to the index’s weighting methodology. The index reweights for major share changes on an event-driven basis, and each quarter, it reweights the entire index membership. This helps negate most of the share count changes and reduces the impact of buybacks on EPS.4

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