Sunday, July 22, 2007

The Out of Balance Balance Sheet: A Hidden Treasure Trove or Fools Gold

One event impacting the stock market of late has been the high level of stock buyback activity. The heightened buyback activity has not gone unnoticed by many, including Standard & Poor's. In a recent report by S&P titled, S&P 500: Buybacks and Treasury Shares The Overlooked and Hidden Assets, they note:
  • Buybacks in 2006 totaled $432 billion.
  • 56.8% of the 500 companies reduced their share count.
  • Buybacks boosted EPS by at least 4% for more than 20% of the issues in 2006.
  • Over the ten quarters between Q4 2004 and Q1 2007, S&P 500 issues spent $965 billion on buybacks, slightly less than the $1,010 billion spent on capital expenditures, and substantially more than the $534 billion paid in the form of common dividends.
  • In 2006, S&P 500 companies spend more on buybacks ($432 billion) than the United States government spent on Medicare ($408 billion).
Some of the more interesting statistics center around the impact of issues' treasury shares:
  • S&P 500 treasury shares increased 19.7% in 2006.
  • The market value of S&P 500 treasury shares is $590 billion higher than their balance sheet posting, and represents 12.4% of the current market value.
For the most part, these buybacks have resulted in an increase in a company's treasury shares. In other words, the company has not retired the shares that were repurchased.

S&P notes if the 338 issues with treasury shares made a mark-to-market adjustment to the value of the shares, the market value increase would be $589 billion. The total market value of the treasury shares would be $1,591 billion, representing 17.6% of their market value. For the S&P 500 Industrials (Old) [see S&P report at link below].

The implication for these companies is:
The availability of this discretionary liquid asset, cash and treasury shares, makes almost every company a potential growth issue and many a potential take-over target. What companies choose to do with this enormous asset is perhaps the most important decision facing them, and it could have long-lasting effects as to their profitability and market value for years to come...Buybacks, while adding to short-term returns, are temporary in nature if the shares are not retired - which they have not been. Cash build-ups that are now being used to supplement earnings via interest income and reduce share count are not a substitute for operating earning and, as such, should not be priced into future earnings or multiples.

S&P 500: Buybacks and Treasury Shares The Overlooked and Hidden Assets (pdf)
Standard & Poor's
By: Howard Silverblatt and Dave Guarino
July 19, 2007

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