Category Archives: corporate finance

31/5/20: S&P500 Shares Buybacks: Retained Earnings and Risk Hedging

Shares buybacks can have a severely destabilizing impact on longer term companies' valuations, as noted in numerous posts on this blog. In the COVID19 pandemic, legacy shares buybacks are associated with reduced cash reserves cushions and thiner equity floats for the companies that aggressively pursued this share price support strategy in recent years. Hence, logic suggests that companies more aggressively engaging in shares buybacks should exhibit greater downside volatility - de facto acting as de-hedging instrument for risk management.

Here is the evidence:

Note how dramatically poorer S&P500 Shares Buybacks index performance has been compared to the overall S&P500 in recent weeks. Since the start of March 2020, S&P500 Shares Buybacks index average daily performance measured in y/y returns has been -15.04%, against the S&P500 index overall performance of -0.89%. Cumulatively, at the end of this week, S&P500 Shares Buybacks index total return is down 10.18 percent against S&P500 total return of -0.967 percent.

While in good times companies have strong incentives to redistribute their returns to shareholders either through dividends or through share price supports or both, during the bad times having spare cash on balancesheet in the form of retained earnings makes all the difference. Or, as any sane person knows, insurance is a cost during the times of the normal, but a salvation during the times of shocks.

18/3/20: What’s Scarier? Corporate Finance or COVID?

Larger corporates in the U.S. are seeking public supports in the face of COVID19 pandemic, from airlines to banks, and the demand for public resources is likely to rise over time as the disease takes its toll on the economy.

Yet, one of the key problems faced by companies today is down to the long running strategies of creating financial supports for share prices that companies pursued over the good part of the last decade, including shares buybacks and payouts of dividends. These strategies have been demanded by the activist investors across numerous campaigns and by shareholders, and have been incentivized by the pay structures for the companies executives.

Artificial supports for share price valuations are financially dangerous in the long run, even though they generate higher shareholder value in the short run. The danger comes from:

  1. Shares buybacks using companies cash to effectively inflate share prices, reduce free float of shares and lower the number of shareholders in the company, thereby reducing future space for issuance of new shares;
  2. Shares buybacks have often been accompanied by companies borrowing at ultra-low interest rates to purchase own firm equity, reducing equity capital and increasing debt exposures;
  3. Shares buybacks generate future expectations of more buybacks, even during the times of financial weaknesses;
  4. Shares buybacks also reduce future firms' capacity to borrow by either increasing debt to equity ratio, increasing overall debt loads carried by the firm or both;
  5. Payouts of dividends also use cash reserves the company can hold to offset any future risks to its financial wellbeing and to invest in organic growth and R&D;
  6. Payouts of dividends create future expectations of higher dividends from investors, reducing firm's capacity to deploy its cash elsewhere;
  7. Payouts of dividends increase cum dividend prise to earnings ratios, reducing the overall capacity of the firm to raise capital cheaply in the future.
These are just some of the factors that overall imply that shares buybacks and payouts of extraordinary (or financial unsustainable) dividends can be a dangerous approach to managing corporate finances. 

So here is the evidence on just how deeply destabilizing the scale of shares buybacks and dividends payouts has been within the S&P 500 sector:

In Q3 2019, shares buybacks and dividends yielded USD1,246.73 billion on a four-quarters trailing basis, fourth highest quarter on record. Overall market yield contributions from buybacks (3.12%) was higher than that from dividends (1.81%), with combined yield of 5.05%. In simple terms, any company operating today will have to allocate 5.05 percent of its return to simply match shares buybacks and dividend payouts yields. This is a very high fence to jump.

Put differently, what the above data shows is that just one, single quarter - Q3 2019 - has managed to absorb more resources in shares repurchases and dividend payouts than what the corporate America is currently asking in financial supports from Washington. 

What's scarier? Corporate finance or corona virus?.. 

17/9/19: Flight from Fundamentals is Flight from Quality: Corporate Risk

Great chart via @jessefelder highlighting the extent to which the bond markets are getting seriously divorced from the normal 'fundamentals' of corporate finance:

Corporate debt has expanded at roughly x2 the rate of growth of corporate earnings since the start of this decade. And corporate bond yields are persistently heading South (see: and investment for growth is falling (see: Which continues to put more and more pressure on corporate valuations. As a friend recently remarked, at 2% interest rates, the game will be over. It might be over at 2% or 3% or 1.5%... take your number pick with a pinch of sarcasm... but one thing is certain, earnings no longer sustain markets valuations, real corporate investment no longer sustains financialized investment models, and economy no longer sustain real, broadly-based growth. Something must give.