The massive cash holdings of U.S. companies is beginning to spill into the stock market. According to the Washington Post, American companies have already announced that they will buy back $273 of stock this year.
What’s interesting is that many companies are announcing buybacks while at the same time maintaining substantial levels of debt.
For example, Pepsico (PEP) announced in March that it would increase its dividend and buy back $10 billion of stock. Meanwhile, it carries about $20 billion in debt, which means that the company chose to buy back shares rather than pay down debt.
You can’t blame them either. It’s the smart thing to do given that in the current market environment Pepsi only needs to pay about 3.9% to borrow money for 10 years from bond-hungry investors, based on the market yield of its 2020 bonds currently. This is historically very low and contrasts with the company’s stock price of $68 which is still below its past peak and trading with a price-to-earnings valuation at the lower end of its historical range.
Pepsi is just one example, but the wave of buybacks reported by the Washington Post is yet another example of how companies can play the gaping spread between stock and bond market valuations right now. Through buybacks, higher dividends, and M&A acquisitions, we’re beginning to see the relationship between the two markets mean-revert, as it just has to, else companies will keep playing the two markets like a fiddle, selling low-yielding bonds and buying depressed stocks of either themselves or their competitors.
Chart graphic via the Washington Post.
Disclaimer: The author owns shares in Pepsico (PEP). His associates could have exposure to Microsoft shares at any time and without notice. This is not an investment recommendation and data may be subject to error despite best efforts. The author’s opinion could change at any time.