Stock buybacks: Short-term gain, long-term pain

Companies are maintaining stock buybacks and dividends payouts despite falling earnings. Combined buybacks and dividend payouts for S&P 500 corporations exceeded earnings by an estimated $572 billion for 2015.

The chart below illustrates how stock buybacks, for S&P 500 stocks, have grown to exceed dividend payouts. The combined figure now exceeds earnings, leaving nothing for investment. The only way to make up the shortfall is to raise debt.

Private nonresidential fixed investment (which excludes inventory increases) is declining as a percentage of GDP.

And corporate debt is rising relative to profits.

But rising debt is not a recent development. Corporate debt has been growing since interest rates started to decline in the 1980s, doubling the corporate debt level as a percentage of GDP.

Corporate profits have also grown dramatically, even when adjusted for inflation. But some of this increase is attributable to unsustainable low interest rates.

And the more debt grows, the more unsustainable corporate profits become.

The graph above shows corporate profits as a percentage of corporate debt (excluding banks and other financial corporations). The lower the level, the greater the risk.

University of Massachusetts economics professor William Lazonick warned in 2014 that companies were forsaking new investment in favor of stock buybacks. His conclusion was that corporate executives are lining their own pockets:

“Corporate executives give several reasons …..But none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay, and in the short term buybacks drive up stock prices.”