The Hidden Stock Market Bid

A few concepts in finance drive divided opinions, one of which is the value of share buybacks.

While investors have broadly embraced them, critics will always point out the colossal failures we have seen from some of the buybacks.

We don’t disagree and look at them like any other financial tool.

If employed appropriately, they can be powerful tools for driving shareholder value. If employed poorly, they can drive a company out of business.

At the start of June, we spent a week going through several types of shareholder capital actions that companies can undertake.

We gave an example of one of the most successful buybacks of all time – AutoZone Inc. (NYSE: AZO). Here is that report and the chart of that stock…

We also shared the story of one of the biggest failures – Bed, Bath and Beyond Inc. (OTC: BBBYQ). Here is that report and the chart of that stock…

This is an example of a buyback that worked very well at first but eventually ended up in disaster.

In aggregate, we think that stock buybacks have ADDED value to the stock market. Are there numbers to back up this idea?

We recently saw an interesting post from the Director of Global Macro Research at mutual fund giant Fidelity Investments. His name is Jurrien Timmer.

A few weeks back, he posted the following on X/Twitter…

This is an interesting concept that we have been thinking about recently.

In the last few decades, share buybacks have moved from being an obscure mechanism used by a select few companies to being part of the mainstream.

There has also been an incredible DECREASE in the number of initial public offerings.

The incredible growth in private equity assets is a big part of that reduction. These funds buy companies in their entirety.

One of our favorite authors – Ben Carlson of A Wealth of Common Sense – recently shared some fascinating data on the shrinkage in the number of public companies.

Here is some of the data:

• In 1996, there were 8,000 publicly listed companies in the USA.

• Since then, the national economy has grown by $20 trillion (double), and the population has grown by seventy million (+20%).

• Today, there are only 4,000 publicly traded companies.

• In 2000, private equity firms owned about 4% of U.S. corporate equity. By 2021, that number was almost 20%.

• Private equity managed less than $1 billion in the mid-1970s. Now, it manages more than $4 TRILLION.

Here is a chart showing the shrinkage of one of the broadest U.S. stock market indices – the Wilshire 5000.

Although it is technically called the "5000", it is closer to 3500 now.

In theory, lower supply with consistent (or growing) demand should raise prices. This is, in fact, what has been happening.

Carlson argues, however, that it is NOT because of the number of companies, and we don’t disagree.

He points out good research that shows that the reduction in companies reflects a spike in smaller companies in the 1990s. Today's publicly traded companies are, on average, older, larger, and much better capitalized.

This also means they are in a much better position to buy back their stock!

We think that stock buybacks have had a positive impact on stock prices.

Returning to Timmer's graphic, we can see that the new issuance has only been $2.7 trillion versus the reduction of $21.3 trillion. The net reduction of $18.7 trillion compares to the total market capitalization of $44 trillion or an astounding 43% of the total.

No wonder the U.S. stock market is up almost +750% (!) since the stock market bottom in March 2009.

The combination of stock buybacks and private equity purchases has shrunk the supply of public stocks. This is because retirement assets to invest in have continued to grow.

We also don’t think this will end anytime soon.

Another table from Carlson's report shows the "dry powder" or unused capital at private equity firms…

It currently stands at almost $2.6 trillion and has still been growing.

This compares to the more than $1.5 trillion in dividends and buybacks that U.S. companies are expected to execute in 2024.

We don't think either of these means that the stock market will never go down again, but we believe there is a “hidden bid” behind share prices!

Check out Enrique Abeyta’s conversation with Gabriel Grego, founder of Quintessential Capital in the latest episode on the HX Podcast, or watch on our YouTube.

Gabriel has been a value investor and activist short seller for more than a decade, focusing on uncovering frauds and illegal activities to identify short-selling opportunities.

While all investors need to do their research, Gabriel has taken it to a near “secret-agent” level of investigation. We’re talking cloak and dagger stuff, dressing up like a delivery man, infiltrating essentially criminal organizations and the like. Not for the faint of heart!

Luckily his experience as a paratrooper in the IDF has given him the nerve, and his education and intellect have given him the wherewithal to sniff out and act upon his discoveries. Lots of great stories and insights to enjoy on this one!