3 Stocks to Benefit from the Secret $6.2 Trillion Stimulus

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Even in the pandemic, the stock market rose 16% in 2020, which is pretty mind-boggling.

Most people expected the heat to die down this year, but the broader market continues to march higher almost every day. 

In fact, the S&P 500 has posted 50 (!) all-time highs in 2021 through August 25, a pace that, if continued, would break the record for the most all-time highs in a year set back in 1995. 

But there’s a big difference from the stock-market mania of the 1990s and today. And that’s because today’s market has a powerful, yet often ignored, driver sending shares higher: stock buybacks. 

Companies in the S&P 500 have repurchased nearly $6.2 trillion in shares since 2009. Just to give you a sense of scale, that’s one-sixth of the S&P 500’s total market cap of $37.2 trillion!

In other words, there’s a ton of stock flowing back into companies — along with cash to their investors. Not many investors are aware of this powerful flow of money. But it’s there, and it’s like a secret stimulus in the market. 

Here’s what you need to know about stock buybacks and how you can profit from them.

Stock Buyback 101

Companies get money when investors buy shares of their stocks. They use that money to run their businesses and hopefully make a profit. Once they’re profitable, companies have two basic options:

  • Reinvest in the business by hiring workers, buying inventory/materials, or making long-term investments in things like equipment 
  • Return the cash to investors 

Obviously, we’re interested in the returning cash part here.

There are two ways to return cash.

The most visible way is to issue a dividend, which means investors get a cash payout based on how many shares of stock they own. In the U.S., companies that pay dividends tend to do so once a quarter, and they strive to raise the payout amount every year. 

But paying dividends is no longer the most popular way for companies to return money to investors. Since 1997, companies have preferred using stock buybacks instead. 

Despite the popularity with companies and the fact that investors are actually profiting from buybacks, many people don’t understand how it all works.

It’s this simple: When a company buys back its own shares, it reduces the number of its shares available on the market — that is, for other investors to buy. This effectively increases your earnings per share (keeping all other factors equal). The lower share count boosts the per-share price. 

If you think about a company as a large pie, share buybacks mean your individual slice becomes naturally larger with no action required on your behalf.

Here are three companies that are returning billions of dollars to investors through share buybacks.

Apple is a buyback juggernaut 

  • Apple (NASDAQ:AAPL)
  • Market Cap: 2,456,382,667,600

When it comes to share buybacks, Apple (Nasdaq: AAPL) is probably the first company most investors think of. That makes sense when you consider that the iPhone maker has repurchased $444.2 billion of its own shares since fiscal year 2012. 

Another way to view this is that Apple alone is responsible for nearly 7% of the total S&P 500 buybacks since 2009. Even better: This is on top of the $113.4 billion in dividends Apple paid in the same timeframe!

Not only is Apple continuing to buy back shares, but it’s been buying more of them than it did in the past. Through the first three quarters of this year, Apple has repurchased $65.5 billion in shares, an increase of 20% compared with last year’s corresponding period. 

With this extreme level of buybacks, it makes sense for investors to wonder if Apple should really be using this much of its profit to repurchase shares. Fortunately, this doesn’t appear to be an issue. 

During the same timeframe Apple bought back $65.5 billion in shares, the company generated $83.8 billion from operations and paid $7.9 billion for things like equipment. All told, it created about $76 billion in free cash flow. Long story short, Apple has more than enough to repurchase stock, invest in its future, and have more than $10 billion in cash left over.

Like all investments, Apple has risks. Ten years ago, the company had no long-term debt but now has $100 billion. Additionally, a significant part of that debt was taken out to buy back shares and pay dividends because of some quirky tax laws that punished companies from “repatriating” cash. 

Despite that, there are numerous reasons to believe Apple can continue buying back shares. The company has nearly $200 billion in cash, cash equivalents, and marketable securities on its books and continues to churn out cash flow. 

Additionally, Apple is moving into subscription-based services, which provide high-margin and reliable cash flow compared with one-off device sales. Look for Apple to continue returning cash to its investors in a major way.

Berkshire is a disciplined buyback company

  • Berkshire Hathaway (B shares) (NYSE:BRK-B)
  • Market Cap: 648,504,053,326

One of the complaints some investors have with buybacks is that many companies do them poorly. Companies tend to buy back more shares when the economy is doing well. It makes sense from an opportunity standpoint because that’s when they have unexpected cash. 

But this is also when stock prices tend to be elevated. The result is that many companies buy back their stocks when the shares are expensive when they (like you) should actually buy the stock when its price is temporarily low, aka on sale. 

As an example, stock buybacks plummeted in the second quarter of 2020 during the pandemic market crash. In hindsight, that was one of the best times in recent history for companies to buy back shares.

You know who didn’t miss out on the opportunity?

Warren Buffett and Berkshire Hathaway (NYSE: BRK-B).

Berkshire bought back $24.7 billion of shares last year. As Buffett explained in his letter to shareholders (italics his), “that action increased your ownership in all of Berkshire’s businesses by 5.2% without requiring you to so much as touch your wallet.” 

Not only is Buffett a fan of buybacks, it’s the only way he believes in returning cash to investors. The company has a longstanding decision to not pay dividends, which makes sense when you consider that your money is being invested by one of the greats. Shares of Berkshire are up 23% for the year as the company’s value portfolio is well-situated for economic growth. 

The Home Depot is the original buyback giant

  • Home Depot (NYSE:HD)
  • Market Cap: 341,281,895,112

Apple gets a lot of buyback street cred these days, but it wasn’t the first mega buyback company. That would be The Home Depot. 

Home Depot (NYSE: HD) has been buying back shares nearly every year of the last 20, starting with a $1 billion authorization in 2003, which was a huge amount at the time. 

Then it raised the stakes with a massive authorization of $22.5 billion in 2007, a figure that was more than 25% of the company’s market capitalization. The Home Depot continues its longstanding history of buybacks, announcing a new $20 billion (or 6% of its current market capitalization) share repurchase authorization in May. This is on top of a dividend yield of 2%. 

Admittedly, it hasn’t been a flawless buyback record for The Home Depot’s management. They have a track record of buying the bulk of its shares when the stock is expensive and refraining to do so when it’s on sale. And like Apple, the company has taken out debt for the sole reason of repurchasing shares. 

However, investors should not let the perfect be the enemy of the good. Shares of The Home Depot are up nearly 850% in the past decade compared with a 286% return for the S&P 500 … and its long-running share buyback program is a significant reason for the outperformance. 

The company has an implicit goal of returning every penny not needed for growth back to shareholders in the form of dividends and share buybacks. It’s been a winning strategy over the last decade, and there’s no reason to expect it to change going forward. 

Buybacks have risks as well 

As buybacks have gained popularity, economists are increasingly warning about the risks. The Harvard Business Review once called them “dangerous,” noting that 30% of buybacks in 2016 and 2017 were done through debt, which increases corporate risk for all stakeholders. 

Consider the recent airline debacle. Coming out of the last recession, America’s biggest airlines spent a whopping 96% of their free cash flow over the past decade buying shares. 

The result was they were so cash-poor when the pandemic hit that they did not have the funds needed to withstand a few months of pandemic-low traffic. Unfortunately, taxpayers had to step in to bail these businesses out. 

Additionally, the Harvard Business Review noted that many executives appeared to be manipulating share prices in the short term with buybacks, taking advantage of short-term boosts to cash in on their lucrative stock options.

However, perhaps the most serious allegation is that many companies are using share buybacks to boost their bottom lines instead of making real investments in the economy, such as hiring workers and buying equipment. Recent economic results aside, sluggish job growth has indeed coincided with the rise of stock buybacks over the past decade. 

The bottom line on buybacks

Like all decisions a company has to make, there are trade-offs with buying back shares. The key to a strong and durable company is to balance the needs of all stakeholders, including employees, management, investors, and suppliers. Apple, Berkshire, and The Home Depot are three businesses doing it well, and you’d be wise to consider buying them in your brokerage.

Jamal Carnette, CFA owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Apple, Berkshire Hathaway (B shares), and Home Depot. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2023 $265 calls on Berkshire Hathaway (B shares), and short March 2023 $130 calls on Apple. Millennial Money is part of The Motley Fool network. Millennial Money has a disclosure policy.

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