Does a slump in share buybacks jeopardize a recovery on the stock market?

As many companies have now put their share buybacks on hold, we are investigating what impact this could have on the outlook for the stock markets.

Share buybacks are said to have fueled the longest boom in US stock market history. As a result, the headlines that dozens of US companies are now closing their programs have raised concerns about the scale of the current wave of sales.

With a share buyback, a company repurchases its own shares on the market. This reduces the number of shares outstanding, and as a result, earnings per share (EPS) and the company's share price increase. However, at times when capital preservation and creditworthiness become a priority, these share buybacks can be restricted.

The fast-food restaurant chain McDonalds, electronics retailer Best Buy and telecommunications provider AT&T have all suspended their buybacks to protect themselves from further economic damage caused by Covid-19. The longer this pandemic continues, the greater the need for liquidity and the higher the likelihood that other companies will do the same. This could take one form of support from the markets at a time when it is needed more than ever.

However, our analysis suggests that fears that a slump in the number of share buybacks could accelerate the current market downturn are exaggerated. The impact of such a development on the overall market is likely to be less than widely believed, as the pace at which the global economy will recover after the coronavirus pandemic will be the main driver of earnings growth, not any share buybacks.

Markets price deteriorating outlook for share buybacks

Warren Buffett once said "Only when the tide comes out can you see who is swimming naked". With the end of the buyback boom, companies that have "doped" their earnings growth per share and thus their share prices are likely to be the hardest hit.

These companies are already under pressure. The 100 leading companies with the highest proportions of share buybacks (buyback volume in relation to market capitalization) have outperformed the broader market since 2008. However, they lost 31% in value in the first quarter of 2020, compared to a loss of 21% in the S&P 500.

W are eshalb share buybacks important

Investors fear buybacks will dry up as US companies have been by far the largest source of demand for stocks since 2007. Indeed, net stock purchases by companies far outstripped other sources of demand, as can be seen in the chart below. ETFs were the second largest buyers, but were still behind companies. Meanwhile, pension funds, households, and mutual funds were all net sellers.

The main problem with this scenario is that it obscures which companies were the strongest buyers. For example, according to data from S&P Dow Jones, the 500 largest US companies have given 3.2 trillion in the past five years. US dollars for share buybacks.

However, the top 20 companies were responsible for almost a third of these total buybacks, and Apple alone accounted for 8%. A more detailed analysis shows that the net effect of discontinued share buybacks will be felt most in a handful of sectors and companies.