Wednesday, April 29, 2015

Stock Buybacks Are Not A Primary Factor In Lower Wage Growth Rates

Recently, a number of articles have been circulating about the need for companies to use more of a firm's cash flow to pay employees a higher wage versus using the cash flow growth to fund stock buybacks. For example,
  • How the Stock Market Destroyed The Middle Class (MarketWatch)
  • Stock Buybacks Are Killing the American Economy (The Atlantic)
  • Profits Are Up, But Wages Are Stagnant. This Senator Has A Plan (ThinkProgress)
The implication in a number of the articles is stock buybacks increase a company's stock price and therefore buybacks are being used to increase the value of senior management stock options. In short though, buybacks have no direct impact on the value of a company's stock price. The below table shows how the share price is unchanged. What can occur is the earnings per share figure can increase due to the lower share count. Other  examples are contained in our post, Proof Buybacks Impact Earnings Per Share. We believe the market is intelligent enough to see through this type of earnings manipulation; thus, not attaching additional value for a firm's stock price due solely to stock buyback activity.

From The Blog of HORAN Capital Advisors

The buyback/wage growth argument has been a popular topic recently given the continued growth in buyback activity. What has been missing from this analysis is what the primary driver of a worker's wage increase might actually be.

Our firm writes frequently about buybacks and dividends paid by companies. In our latest buyback update, Strong Buyback Activity Reducing Share Count, we included the below chart which shows the increased buyback and dividend payments going back to 2001.

From The Blog of HORAN Capital Advisors
Data Source: S&P Dow Jones Indices

This increase in buybacks has not gone unnoticed by investors as can be seen in the below chart detailing the growth in the S&P Buyback Index along with the growth in average hourly earnings.

From The Blog of HORAN Capital Advisors

On a year over year percentage change basis, the below chart compares the performance of the buyback index to the change in average hourly earnings. The change in hourly earnings growth has a correlation with the buyback index at just above .9 (1.0 is the highest possible correlation.) Given this high level of correlation, could reducing the level of buybacks actually result in a lower rate of wage growth? Certainly the percentage growth rate of buybacks far exceeds the growth rate of wages; however, the wage growth rate of 1.75% is higher than the growth rate in mid 1986 of 1.59%. This begs the question, what is the primary driver of wage growth? And what may drive wage growth to a higher level?

From The Blog of HORAN Capital Advisors

Aside from the potential supply/demand imbalances of certain job positions that can influence wage growth rates, the below chart shows what we believe is the primary factor that influences changes in wage growth rates: inflation. The chart below compares the yearly inflation rate to that of the percentage change in average hourly earnings. Clearly, higher levels of inflation lead to higher wage growth rates.

From The Blog of HORAN Capital Advisors

The latest report on inflation shows the YOY inflation rate is negative. This fact alone will be a headwind for faster growth in employee hourly wage rates. Much more can be said about the way in which corporate managements are compensated, elevated option grants, etc. However, increases in stock buyback activity is not a significant variable in the growth rate of wages in our view.

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