Scott has written plenty on part of what has been driving stock markets higher the last number of years, aside from the obvious, which was clearly reinforced yesterday being easy monetary policy from the Fed and other central banks; those being, share buybacks and dividends. Both of these come at a cost to future earnings. And when investors buy a stock, they buy a future stream of earnings that get discounted back to today to determine the present valuation on that individual stock.
Think about it. If a company increases it's dividend or buys it's own stock back, what it is really telling investors is, "we have no other use for our capital right now so we are going to give it back to you in the form of dividends and share buybacks". Capital expenditures (capex) is what companies usually use Operating Cash Flow (OCF) for...ie...to re-invest back into their business for the future. Growth companies typically do not pay a dividend because they firmly believe the best use of any OCF, if they even have any, is to re-invest in their business. Mature businesses are more apt to pay a dividend.
So let's look at Microsoft as an example of a mature business (at least I think it is but who knows, maybe they still consider themselves a growth business?) who has been doling out the cash to shareholders hand over fist. And the reason I use Microsoft as an example is because Tues Sept 20, 2016, right after the 4pm stock market close, they announced a $40bln share buyback over the next year. That works out to about 10% of their outstanding shares. Now what really hit me up was, Microsoft just issued about $20bln in corporate bonds in early August. So they increased debt by $20bln to buy back $40bln worth of stock....is that called increasing leverage?
Whatever they are doing seems to be working. Here is the stock chart:
Part of what is working is the increasing of Dividends:
And another part of what is working is share buy backs:
But to accommodate the stock moving higher through increased dividends and share buybacks, something is also increasing, and it ain't always good - Leverage. Defined as Debt / Ebitda (cash flow), leverage has been increasing rather substantially:
So there you have it, Microsoft is increasing leverage (debt) to pay dividends and buy back their own stock. Leverage, as you can see from the chart above, has increased by almost 3 times over 2yrs (from .7x leverage to 2.0x leverage). Coming from a long-time credit Portfolio Manager who has been modeling and looking at credit metrics, like leverage, for 20 years, 2x leverage is getting up there. Heck, at High Rock in some of our BNS-managed High Yield Bond Funds, we own some high yield bonds where the credit metrics are less than 2x!
But hey, the stock keeps going up. And guess how Management get paid? Ya, it's usually via stock, not on how low they can keep their leverage.
What will kill the music?