• Investing & Markets

Companies Taking Advantage of Low Valuations With Stock Buyback

January 18, 2012 | Daily Capital

Shrinking equity supply is bullish as it supports higher prices. With valuations at such low levels, we fully expect share buybacks to continue. The S&P 500 has a forward P/E ratio of 12.3x. That means its earnings yield is approximately 8.1% (the inverse of its P/E) which is much higher than current bond yields. In other words, companies can use debt to buy back stock and earn the difference between their own earnings yield and the respective bond yield. Easy money.

U.S. Market Shrinks Amid Heavy Buybacks

Stocks are getting scarcer in the U.S. for the first time since the bull market began as companies cut share sales to the lowest level since 2006 and buy back equity at the fastest pace in four years. Amgen Inc. (AMGN), Hewlett-Packard Co. (HPQ) and 1,971 other U.S. companies repurchased $397 billion of stock last year, while they issued $169 billion of new equity, data compiled by Birinyi Associates Inc. and Bloomberg show. The combination reduced the Standard & Poor’s 500 Index divisor, a measure of outstanding shares, by 0.6 percent last quarter, the first drop since March 2009. Shrinking supply supports prices and shows valuations are so low that executives would rather buy back shares than spend the cash to expand, according to Columbia Management Investment Advisers LLC and USAA Investment Management Co.

Read the rest on Bloomberg Personal Finance.

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