February 25, 2013 at 06:31 AM EST
Why Corporate Earnings Have Yet to Collapse

250213_PC_lombardiAs the key stock indices, like the S&P 500, move towards their pre-financial crisis highs, a popular trick for increasing per share earnings is becoming even more popular—companies are buying their own shares to prop up earnings.

Call me a skeptic, but when I see S&P 500 companies buying back their own shares, I think two things: 1) companies are scared to spend their cash elsewhere; and 2) they are pushing per share earnings up, reducing the amount of shares in circulation as opposed to recognizing real earnings growth.

If a company has one million shares outstanding and earns $1.0 million in profit, corporate earnings of this company would be $1.00 per share. Now, if the company buys back 50,000 shares and earns the same profit, earnings per share (EPS) goes up to $1.05—an increase of five percent.

As an example, Safeway Inc. (NYSE/SWY), an S&P 500 company, reported it earned $0.94 per share in the fourth quarter of 2012. But the company’s earnings were much lower if you consider its share buyback. Over the quarter, this S&P 500 company spent $1.2 billion to buy back its shares, boosting per share earnings by $0.17. (Source: Market Watch, February 21, 2013.)

But Safeway isn’t the only S&P 500 company involved in buying back its own shares. Like many other companies, Texas Instrument Incoporated (NYSE/TXN) is using a massive amount of its cash holdings to buy back its shares. The company just announced that it will purchase another $5.0 billion worth of its own shares, bringing the repurchase total to $8.4 billion. (Source: The Globe and Mail, February 21, 2013.) While announcing its fourth-quarter corporate earnings, the company warned investors about fluctuating demand for its products due to economic uncertainty.

Other big names in the S&P 500 are taking similar actions. In the fourth quarter, The Coca-Cola Company (NYSE/KO), Pfizer Inc. (NYSE/PFE), and General Electric Company (NYSE/GE) all announced that they were planning to buy back $10.0 billion worth of shares each. (Source: Chicago Tribune, January 27, 2013.)

In the first nine months of 2012 alone, S&P 500 companies spent $299.8 billion to buy back their own shares!

Dear reader, what this all tells me is very simple. Businesses, just like the individuals in the U.S. economy, are scared. They are not making investments, which create jobs; rather, they are buying back their shares to make their corporate earnings look better than they actually are.

Funny enough, as companies on the S&P 500 continue to buy back their shares, optimism among investors seems to be increasing. I saw one stock advisor forecasting significant upward moves in the key stock indices, suggesting the Dow Jones Industrials Average will reach 20,000 and the S&P 500 will reach 2,500. But I see the road ahead in a very different light…and that’s a road that includes a stock market moving lower, not higher.

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