Yves here. Wolf is flagging the end-game in the efforts to present US corporate earnings as being on a decent upward trajectory. The fact that Apple disclosed last week that it spent $14 billion in a two-week period buying back stock should be seen as a massive sell signal. As one of my stock jockey buddies remarked, “If the company won’t invest in its business, why should I?”
And that’s before you get to all the other games public companies have been playing: lowering earnings guidance so they can claim to beat the easier targets, the reliance on accounting tricks (reader Scott pointed out that when IBM, famous for strained accounting to maintain earnings growth, couldn’t maintain the momentum, you knew that the economy was weaker than the cheerleaders wanted you to believe) and for many supposedly industrial companies, the use of Treasury as a profit center (for Toyota and other major manufacturers, we noted in ECONNED that financial operations accounted for roughly 25% of earnings. It’s hard to imagine that the financialization of large corporations has done anything but increase).
This level of stock buybacks isn’t opportunism; it’s tantamount to disinvestment. Yet the top brass are able to maintain or even increase their lofty pay levels using these ruses.
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Testosterone Pit.
Last quarter was tough on large US corporations – those that make up the S&P 500 index. Unperturbed, the index, which had been soaring all year, ended 2013 up nearly 30%. But its 343 companies that have reported earnings for the last quarter so far, according to Thompson Reuters IBES, have exposed the ugly underbelly of the worldwide economy: revenue “growth.”
Growth in quotation marks because the US Consumer Price Index ticked up a relatively tame 1.5% in December from a year earlier. So beating inflation by a smidgen wouldn’t seem to be such a heroic feat. But no! Fourth quarter worldwide revenues of these US stalwarts, after inflation, actually declined.
Only one sector did well: healthcare, the monster that is eating up the US economy. Revenues grew 7.6%. Perhaps the Obamacare effect.
Other sectors had subdued revenue growth, but nevertheless growth: consumer discretionary up 3.8%, consumer staples up 1.9%. They’re the largest two sectors. Industrials up 2.3% and utilities up 4.2% – it was seriously cold in December! Technology, the high-growth sector, the grand hope for the US economy, the area where American ingenuity and creativity can still blow away all challengers… well, revenues rose a measly 5.4%. And telecom services eked out a barely visible 2.2% revenue gain. Not exactly breath-taking growth figures.
But then there were the third and fourth largest sectors: revenues in the energy sector dropped 3.4%; and in the financial sector, they plunged 11.4%.
So, while inflation was 1.5%, the S&P 500 companies that have reported so far, all put together, triumphed with year-over-year revenue growth of, drumroll please, 1%.
Those are worldwide revenues. Revenues outside the US are a big part of S&P 500 luminaries like GE and IBM. GM, for example, has long been the number one brand – though it fell to number 2 last year – in what has become the largest automotive market in the world, and one of the fastest growing ones, China. Even with this tailwind, worldwide revenues only inched up 3%.
But wait, Wall-Street hype mongers are crying out, revenues don’t matter; what matters are earnings per share. In the fourth quarter, companies pulled out all stops to show, despite the dreary revenue picture, that they could still perform miracles when it came to earnings per share, and they sweated over it, and they worked on it, pushed and fudged things, and used the most effective Wall-Street engineering that money can buy to report 9.5% growth in earnings per share.
All sectors showed EPS growth, except utilities (- 3.8%) and energy (-7.9%). Telecom services, dogged by a revenue gain of only 2.2%, booked dizzying EPS growth of 24.5%. The materials sector, equally dogged by a revenue gain of 2.4%, came up with EPS growth of 24.5%. Industrials, with sales up merely 2.3%, wound up with EPS growth of 14.1%. And then the winners of this ingenuity, the best of the best, the star, the most creative in their recklessness and the most aggressive in their accounting, were financials – whose revenues plunged 11.4%. They contrived EPS growth of 24.4%.
What the dickens is going on?
Ingenious accounting is one element, financial engineering another. Corporations can borrow nearly unlimited amounts of money in the short-term markets and through bond sales, at little cost, thanks to the Fed’s policies, and load up their balance sheets with borrowed cash, that they then plow into share buybacks. This accomplishes a number of things.
It spreads the skimpy net income over fewer shares, thus artfully goosing EPS. It’s the number that matters we’re incessantly told – because it’s the number that is the most easily manipulated.
Buyback announcements, which by sheer coincidence often come alongside revenue and earnings debacles, are designed to boost shares, or keep them from falling off a cliff. Later, as the buybacks are being executed, the additional demand for the shares drives up prices again. And best of all, the entire procedure – borrowing money to buy back shares – hollows out stockholder equity and fills the ensuing hole with debt. This has left many corporations, as far as shareholders are concerned, mere skeletons ready to topple if credit ever dries up, as it did during the financial crisis [read…. How Stockholders Get Plundered In IBM’s Hocus-Pocus Machine].
But it does one heck of a job in jacking up earnings per share.
And there’s a more insidious side effect. By plowing cash into stock buybacks rather than productive assets, such as factories or IT equipment or systems that might be a little more difficult to hack into or even (God forbid) workers, corporations are inserting their own neck into a stranglehold that will continue to crimp revenue growth. But short-term, it performs a nose job on earnings per share.
A valiant strategy in an era when central-bank money printing and interest rate repression has surgically separated reality from stock prices. In this manner, the doctored EPS growth – and particularly the “expected” doctored EPS growth for distant future quarters, which invariably is in the double digits – is bandied about as illusory justification for the gravity-defying ascent of stocks.
Business success, as defined by growth in revenues and net profits and not by financial engineering and artfully fabricated EPS, is crucial to the economy. But for a quarter of a century, corporate profits have been rising at a faster rate than GDP and are now “dangerously elevated by all reasonable measures,” writes Chris Brightman, Head of Investment Management at Research Affiliates. The phenomenon is the result of a spectacular reallocation of income from labor to capital. It repressed wages and created the biggest profit bubble ever. But pressures have reached a tipping point. Read…. The Unglamorous End of the Largest Corporate Profit Bubble in History