If Leveraged Buybacks, Why Not Leveraged Dividends?
The equity investing community seems to get giddy when it hears the words "stock buyback." And why not if the stock is being bought back out of current profits? But what if the corporation is increasing its debt to fund its stock buybacks? The chart below suggests that is what is occurring now and what occurred in the late 1980s and late 1990s. The red bars in the chart represent the dollar amount of the net issuance of equities of nonfinancial corporations. Readings below zero, which predominate, signify the net "retirement" of equities. As the chart shows, record amounts of nonfinancial corporate equities are being retired in this cycle. The blue line in the chart represents nonfinancial corporate borrowing as a percent of their nominal capital spending. If the percentage is rising, as it is now, then this indicates corporations are borrowing for purposes other than to fund their capital spending. If corporate borrowing is rising relative to capital spending and corporations are retiring equity, then it is likely that they are borrowing to fund their share buybacks.
Chart 1
Equity investors do not seem alarmed that corporations are leveraging themselves to fund stock buybacks. Would corporate borrowing to increase dividend payments be greeted equally as gleefully?
As an aside, with some risk starting to be priced into the credit market, funding stock buybacks via borrowing is getting more expensive. Ask Expedia. It recently had plans to buyback 42% of its shares, predominantly with borrowed funds. But with the credit markets having turned more discriminating in recent weeks, Expedia has scaled back its repurchase plan to only 8% of its shares. If creditors continue to become more risk averse and stocks begin to trade on the outlook for profits rather than buybacks - well, I don't even want to speculate on how long it will take to get the Dow up to 15,000 or maybe even 14,000.
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Author: Paul Kasriel
Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.
Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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