Travis Gallton, The Daily Record Newswire
After recording a remarkable advance of more than 32 percent last year, investors are much more cautious. In part, their apprehension is driven by nervousness that a more than five-year-old bull market, which happens to be the fourth longest in duration since 1932, is nearing its final stages. Additionally, there have been many signs that warrant caution when examining the levels of margin lending, the amount of merger activity and the pace of company stock repurchases.
Looking at the last of these signs, stock repurchases are when a corporation buys back its own shares in the market and then retires the shares, thus reducing the number of outstanding shares. The direct impact of reducing outstanding shares is that a company can boost Earnings Per Share, a closely watched measure of profitability. Stock repurchases can be viewed in two different ways.
On a positive note, a buyback signals the company feels that its stock is undervalued and represents the best use of its capital. Buybacks can also be seen as a sign of confidence by management that its purchase does not restrain a commitment to future cash flows like a dividend policy would.
On a negative note, share repurchases imply that companies do not have enough valuable capital projects that provide positive cash flows that outweigh their capital cost. Additionally, repurchases not only reduce the potential long-term capital the company can use to grow, but they also mask the organic (real) EPS growth of a company.
EPS growth can be broken down into sales (revenue) growth, net margin growth (profit after costs), and share repurchases. When taking a glimpse of stock repurchases in 2013, it was a monumental year amassing close to $480 billion, or over 28 percent growth from the previous year. This marks the largest increase in stock repurchases since 2007.
Adding to today’s U.S. equity market backdrop, we currently have some of the highest net profit margins witnessed in history. Combined, these factors indicate that since corporate America has relied heavily on cost cutting and equity retirement, we now need revenue growth to propel results in 2014.
Given this, the obvious question is: What is the impact on investing in 2014? If we take a look at the current market dynamics, since the end of March, there has been a clear change in market leadership. There has been a distinct shift from high growth, small capitalization momentum stocks to large cap value and international stocks. Although it’s too early to tell if this is a temporary market change, it does show that investors are starting to favor high quality, cheaper stocks and feel skittish in higher-beta, growth-dependent stocks.
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Travis M. Gallton, CFA, is a senior equity portfolio manager for Karpus Investment Management. Offices are located at 183 Sully’s Trail, Pittsford, NY 14534; or call (585) 586-4680.
