art of why S&P 500 earnings per share has been rising has nothing to do with earnings and everything to do with the amount of shares outstanding in the market.
As companies buy back stock, reducing the number of shares outstanding, the ratio of earnings per share naturally increases.
Miller Tabak chief economic strategist Andrew Wilkinson gives a simple reminder of why investors love stock buybacks in a note to clients this morning: holding those companies tends to be much more profitable than holding the broader index itself.
The S&P 500 Buyback Index is up 250% since December 31, 1999, while the S&P 500 is up only 20%, as the chart above illustrates.
The buyback index is comprised of the 100 companies in the S&P 500 with the highest buyback ratio — cash paid for the buying-back of common stock divided by the total market capitalisation of common stock — over the preceding four quarters.
Wilkinson breaks down the popularity of share buybacks by sector:
The sector that over the period 2011-October 2013 has performed best within the buyback index is the financial sector. Repurchases by 18 financial names within the index has restricted the available pool of equity outstanding to investors by 10%. During that time shares of those companies have increased on average by 71.%. By contrast the next best performing sector is the industrials space, where supply has only been restricted by a mere 1%. Share prices amongst 11% of the buyback index have advanced by 66% since the start of 2011.
Four sectors have witnessed a double-digit pace of share buyback (financials, consumer discretionary, basic materials and telecom). However, the telecommunication services sector, which is represented by only one company, is the worst performer within the sector space (but not across companies). The average gain over this near-three-year period amongst these sectors is 50% while the S&P 500 index is higher by 40%. Only IT and telecom failed to match the gain of the broad S&P 500 index.
With the exception of the sole company purporting to represent the telecom sector, each group beat the overall sector in terms of performance. The only close shave was the discretionary sector where buyback names beat the group of non-buyback companies by the narrowest margin.
“One available ETF that attempts to isolate the performance of companies reducing the available supply of shares outstanding is the PowerShares Buyback Achievers (Ticker: PKW),” says Wilkinson. “While the S&P buyback index has increased by 57% over the near-three year period under our microscope, this exchange traded fund has risen in value by 54%.”
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