"If underleveraged companies relever to two-times net debt to EBITDA, 20 percent of market cap can be bought," said Andrew Garthwaite, global equity strategist at Credit Suisse, in a note. The rise in interest rate costs "would be more than offset by a decline in the number of shares, leading to a rise in EPS of 21 percent in Europe and 18 percent in the U.S."
The total value of the U.S. stock market is $13.8 trillion using calculations based on the Wilshire 5000 Index. A fifth of that works out to be $2.76 trillion. Taking that supply out of the market, would surely lift share prices. Microsoft has done the math, selling almost $5 billion in debt at its lowest coupon ever this week in order to finance buybacks. The only question is, will the rest of companies follow?
"It’s short-term bullish trend," said Guy Adami, managing director for Drakon Capital and a ‘Fast Money’ trader. "But it’s long term bearish as investors will start to question whether companies just don’t have better ways to use the cash."
Companies are sitting on a record mound of cash relative to their assets. Standard & Poor’s said yesterday that S&P 500 stock buybacks more than tripled in the second quarter of 2010 from one year ago to $77.6 billion.
"We have effectively moved from a period when companies were reluctant to touch their stock, to a point where companies are now protecting EPS dilution via share count reduction," wrote Howard Silverblatt, senior index analyst at S&P Indices.
This is no free lunch however. If interest rates remain low enough for all U.S. companies to pull this off, that could be because growth is so anemic, that rates refuse to budge. That could take investors’ focus away from share count reduction and back on the economy.
"If I bought a big red nose, I could run off and join the circus," said Brian Kelly, founder of Kanundrum Capital. "Just because they can, does not mean they will. If the market chooses to focus on revenue, then buybacks will not help."
The possibility of a double-dip recession is also likely keeping CFOs from around the country from executing this strategy. They don’t want to buy back shares that could take a hit from another recession. Nor do they want to issue debt that could not be refinanced amid another credit crisis. So alas, it may just remain a sales trader’s dream.
"It shows great underlying value in equities," said Karen Finerman, President of Metropolitan Capital Advisors. "It is not unreasonable, though, for companies to be conservative in the wake of the financial crisis. It won’t happen."
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