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
Surely we have all seen enough westerns to know how to salt a goldmine. What I see no sign of is research demonstrating what effects the financial wizards have of the rest of us. I want a discourse outside that in which we still treat them as wizards rather than con men and must play by the rules of magic.
These arguments are all so dumb we still clamour for more factories as productive investment when new ones will be automated and kill jobs and ‘productive investment’ to produce as we have been doing is burning the planet. There are no solutions in any magic analysis. The metaphor for economics now is that of a Monopoly game in which the banker funds her own losses by sleight-of-hand. Other players actually know this and try to compensate by bringing extra sets of the game currency in their pockets. There is now no way to win the game by playing to rules and the rub of the dice.
Over the last several years I’ve witnessed more and more companies gaming their stock price. Companies are sacrificing long term strategies for short term gain for the execs. Example…. this particular firm will remain nameless.
Company X sells cutting edge products worldwide. When a sales quarter comes up short, they implement two accounting games to get the stock price up. First, they will announce lay-offs or some other cost cutting measure…. then later on…. when that bit of news sinks in and the stock price wanes they push the second tool-in-the-shed. They ship (sell) products just before quarter close to countries that have no ability to pay for them and will send the same (usually end-of-shelf-life) products back because they don’t have customs clearance with the importing country. As far as that quarter goes, the sales numbers are up due to a sleight of
This pyramid scheme does catch up to the company. They will just announce it as a bad quarter…. but hey, the previous three were good. Right? The excess inventory becomes a footnote. So what if earnings are weak? Onto the next gaming cycle!
All the result of ever more cadres of “clever young men” in the Big Four carefully min-maxing, twisting and manipulating existing rules, “optimizing” existing code and procedures to ultimately destroy the modern system of accounting as we understand it today.
We knew all this was coming back with Aurthur Andersen and Enron, yet nothing has been done. Professionals like accountants weren’t supposed to incorporate for just the reasons we are seeing now in the big accounting and legal firms: Incorporation reduces personal accountability and encourages unscrupulous, unethical manipulation of the rules and more importantly a betrayal of the public trust in such professions. The net result is the disaster we now see in companies high and low across the land.
Accountancy organizations could stop all of this tomorrow morning, but not by tightening rules. Rather the change must be in the size of firms which are allowed. The Big Four walk, swim, and quack like an incorporated company of accountants. That can’t be allowed to continue.
“healthcare, the monster that is eating up the US economy”
Yeah, taking care of people is a “monster”… this guy is probably on board with Rattner’s “death panels” too… probably thinks “we can’t afford it….”
Health care costs twice as much per person if not more than in any other advanced economy and is growing faster than GDP. Saying we have a lousy, bloated health care system is hardly radical. We’d be better off outsourcing it to Canada.
20 years ago, I thought we should invest like crazy in health care: research, professionals, etc. Since we are only 35 millions, we could have been the world leaders in health care without flooding it.
But health care is always seen as a cost and is not sexy. So we invested in real estate and cars just like everybody else.
He should have said ‘health INSURANCE’.
We certainly cant afford to pay almost twice as much per capita as other first world nations thanks to bloated health insurance monstrosities!!!
“Yeah, taking care of people is a “monster””
Taking care of some people too much (which is dangerous for one’s health BTW) while neglecting an ever growing % of the population is a monster.
Refusing to play by market rules by preventing price discovery, while bawling out loud that we have a free market health care is a monster.
Shoving million dollars gizmos into surgical rooms before any meaningful efficacy and safety tests have been done sure is a monster. (robotic surgical devices)
Making cosmetic changes on a out-of-patent molecule to gain FDA (paid for) approval and then charging patient and insurance to the hilt under the guise of an ill-gotten patent is a monster. (Avastin v Lucentis)
Where have you been in the last century?
I feel like standing up in front of my screen and clapping and cheering over this comment.
The markets are a comical farce, with distortions as far as the eye can see. What we are now witnessing is a market based not on value but on bullshit, and the accounting gamesmanship is reaching epic proportions courtesy of the Fed’s failed policies. Instead of allocating capital toward building a sustainable, productive economy, the titans of Wall Street are pimping themselves out for EPS gains and year-end bonuses. Gluttony, greed, sloth, wrath, pride, lust, envy…..that pretty much sums up corporate America these days.
This sort of stuff has been going on, in different forms, for a long time in the corporate sector and will continue. Still the ship keeps sailing and money circulates and it goes on and on. Smoke and mirrors, con-games, fraud, thievery and every kind of activity just keeps the economy rolling along. Shouldn’t we ask the question: why doesn’t it all crash? The system works–trucks are all over the roads people are buying stuff and life goes on.
My theory is that it’s all about the confidence fairy. People see no other way to live so they keep going and that covers up a lot of ugly somehow.
There is the confidence fairy, but I wouldn’t overlook narcissism. A Lehman systemic collapse can’t happen again because the actors involve know how to make TARP and other bailouts work even better and for smaller price tags, so if something happens, it will be solved. They are too arrogant to address the causes of the Lehman collapse or why the politics will be different when the need for a bailout arises versus 2008 when the elections were sealed and an unpopular outgoing President’s administration was doing the heavy lifting.
More on Apple’s share buyback. Icahn: infamous corporate raider. See history of TWA airline.
Yes, I was remiss in not mentioning the proximate cause. But the timing happens to have coincided with the announcement of disappointing iPhone sales. They could just as easily have made Ichan go away by doing a “mere” $500 million or $1 billion in immediate buybacks and committing themselves to distributing the rest of the excess cash to shareholders in the next 12 to 24 months.
Hey, ya’ think this article and the “crapification” one are related? Hmmmm…..EPS goes up, quality of goods/services goes down….correlation or causation, you be the judge.
But the Fed has not directly bought stocks yet. Once they do, it’s off to the races once again.
They’ll just attribute it all to the need to maintain employment:
1. Fed buys stocks.
2. Trickle down economy and other BS.
3. More employment.
What could go wrong with that?