American Consequences - February 2019

WHAT COULD POSSIBLY GO WRONG?

Financial follies and disaster in the making

Buybacks are hugely popular among CEOs and CFOs of publicly traded companies for two reasons... First, they increase a company’s EPS without any actual increases in earnings. By reducing the number of shares outstanding, management can increase EPS without any changes to profits. This makes EPS one of Wall Street’s favorite financial metrics... Companies are rewarded with higher stock prices when their EPS jumps. That leads to the second reason executives love share buybacks: Top executives earn millions of dollars with bonuses and stock options tied to EPS and share price... which is plenty of incentive to buy back shares and artificially inflate EPS quarter after quarter. Companies have taken on huge amounts of debt to pay for these buybacks, and it’s only expected to get worse... Analysts project nearly $1 trillion in buybacks this year, far exceeding 2018’s record $770 billion.

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U.S. corporate earnings – and more specifically, corporate earnings per share (“EPS”) – have been on a tear. After declining for seven consecutive quarters in 2015 and 2016, EPS of companies in the S&P 500 soared by double-digit percentages through September 2018. And with roughly half of the companies in the S&P 500 reporting fourth-quarter 2018 results to date, that streak almost certainly extended to end the year. Unfortunately, that momentum has turned... Wall Street analysts are now forecasting EPS could decline this quarter for the first time in three years, anticipating a 1% drop in earnings per share versus an expected 3.3% increase. If true, it would be the first such contraction since the second quarter of 2016. And falling analyst estimates aren’t the only reason for concern... This trend has been fueled by a huge boom in debt-financed share buybacks.

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February 2019

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