I am sick and tired of reading stories about how buybacks inflate earnings and are, therefore, phony.
Today The Wall Street Journal reports that companies bought back $189 billion of their own shares in the first quarter and that the total in the second quarter may be even bigger.
That's much bigger than the $137 billion in any of the six quarters before the tax changes, the Journal says.
Then we get the usual litany of companies that pumped up earnings with buybacks, including Union Pacific Corp. (UNP) , Southwest Airlines Co. (LUV) and, of course, Apple Inc., (AAPL) , which is a holding of my Action Alerts PLUS charitable trust.
Let me tell you why this reasoning leaves me cold. First, when buybacks started they were novel enough that fund managers really didn't recognize their power. They reacted positively to each surprise they generated.
But over time fund managers got wise to their power. Now it is seen through immediately. Every time you get a "phony" upside surprise, so to speak, it's pretty universally acknowledged as so.
More important, though, is the incredible power these buybacks have on the S&P 500. I have propounded for some time the notion that the far more powerful impact of buybacks is their role in sopping up supply.
We have a seemingly endless wave of savings coming into the S&P 500. It is not one that has slowed down from higher rates. It hasn't slowed down from higher price-to-earnings multiples. It has not slowed down because of tariffs. It has not slowed down because of the aging of baby boomers. It has not slowed down because of the money that went to FANG, meaning the concentration of winners in technology that has created a couple of trillion-dollar companies with others behind it.
It has defied every prediction about how there would come a time when there would be much more money coming out than coming in, including predictions that were made during moments when there was more money coming out of some stock funds.
Now consider the simple equations involving both mergers and acquisitions of S&P 500 companies and the lack of new issuance of the companies in that index.
Both take out a tremendous amount of stock. Both make it so there isn't a lot of new supply coming on in these 500 stocks. They are far more net curtailers than issuers. And because there is so much cash flooding in, especially after the tax cuts, you are dealing with an extraordinary situation where the S&P 500 index funds, which don't sell shares if they keep getting money in, act as if they are stock buybacks, too.
Take a look at the holdings of large S&P 500 stocks and you will see the same big shareholders time and time again. It's State Street, Blackrock, Vanguard, Fidelity. So often I see them owning 20% of the shares outstanding -- or more -- of companies big and small, many of which have colossal buybacks.
Remember that the index funds do not care how much the earnings per share are. They don't care how the earnings per share were arrived at. All they care about is if you are in the S&P 500 Index.
It's this by rote buying that creates a supply-demand imbalance that was never thought about when these indices were invented.
So, yes, I am not disputing the notion that earnings per share year over year are being inflated. What I am saying is that no sophisticated fund manager is fooled by the buybacks that took in, say, 5% of Oracle Corp.'s (ORCL) stock this quarter or 16% of Signet Jewelers Ltd.'s (SIG) stock last quarter or any of the ones mentioned in the Journal.
No one is fooled except journalists who don't understand the power of S&P index funds on a shortage of supply that has systematically buoyed prices over time.