On Tuesday, Oct. 10, Wal-Mart Stores Inc. (NYSE: WMT) announced a plan to buy $20 billion worth of its own stock back from the market.
I was excited, but the reaction was mixed.
You see, there’s a short list of reasons academics and analysts don’t necessarily love buybacks…
Companies buying back potentially overvalued stock instead of paying down debt… The way buybacks mask iffy earnings per share (EPS)… The fact that there doesn’t seem to be a long-term benefit… The cash spent on buybacks could be spent on growth…
Those are all valid reasons, but they’re arguable. Besides, it doesn’t really matter for our purposes.
You see, in the here and now, investors and traders (including this one) generally love buybacks, because they drive market value and share prices, boost EPS, and hike dividend payments.
And when you’re a rules-based trader, making fast cash by moving in and out of a profitable position in a week or a month, the long-term sustainability of the executive board’s decisions matters a whole heck of a lot less.
And that’s why this year’s real lack of buyback action – down nearly 10% from the first quarter and 5.8% year on year – could mean trouble ahead, especially here in the thick of earnings season.
So, here’s what I’m looking out for…
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The "Drought" Slows the Rally and Dings Your Profits
A buyback plan announcement sends a very clear message to investors. In short, the board says:
“We think our shares are undervalued, we want to boost EPS, and, most of all, we think the risk of some kind of financial emergency that would drain our cash hoard is low – really low – so we’ll buy back a bunch of our stock from you.”
That’s a message investors, traders, and the stock market as a whole loves to hear.
And we are not quite hearing it right now.
It’s a little concerning that, of all the S&P 500 companies, only 66 reduced their available shares by 4%. That’s down from the 134 companies that reduced their shares in the same period one year ago and the 71 companies that did this in the first quarter of 2017.
And if this continues, here's how it could hurt your portfolio…
Fundamentally, when a company buys its own shares back, it reduces the number of available shares you can buy.
So long as demand is strong – which is often the case with a strong earnings report and future projections – it drives the stock higher.
It’s simple supply and demand: You’ve got the same number of people, if not more, trying to buy fewer shares, which keeps pushing the share price higher.
As you can imagine, this creates strong bullish opportunities in the market – particularly for options traders. In fact, the huge rally we've seen in the markets can be largely attributed to massive buybacks from the likes of Apple Inc. (Nasdaq: AAPL), Pfizer Inc. (NYSE: PFE), and CVS Health Corp. (NYSE: CVS).
Of course, there are signs that the “buyback drought” isn’t something we need to worry about all that much.
Here's Why This Might Not Be So Bad
The other distinct possibility is that companies believe they’ll be able to meet, and even exceed, their EPS projections without the need for buyback programs on the $1 trillion-plus scale we saw in 2015.
That would be a good thing.
It's also possible that they're simply waiting for a repatriation of capital from overseas to investors and for Congress to act on Trump's enormous tax reform wishes.
But until that happens, we'll likely see this drought continue.
And I’m going to be watching three very important companies very closely for signs that it could deepen or turn into something worse. That could throw some cold water on bullish opportunities, compelling us to change our stance, or bias, to something a little more bearish.
I’m looking hard at…
Amazon.com Inc. (Nasdaq: AMZN);
JPMorgan Chase & Co. (NYSE: JPM); and
Coca-Cola Co. (NYSE: KO).
These are all really important players and high flyers in their respective sectors, and if they’re moving to stop or slow buybacks, we’ll know something’s rotten.
Whatever happens, whether we get a deepening drought, a “buyback apocalypse,” or a buyback “feast,” you can be sure you’ll hear from me with trading strategies and trade considerations that will give you the best cash flow.
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About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.