my bolds my comments in blue
Record-low interest rates are stoking the biggest increase in U.S. share buybacks ever.
American companies announced $55.9 billion in repurchases since June, data compiled by Birinyi Associates Inc. show. That adds to $93.5 billion in the second quarter and $108.3 billion during the first three months of the year, compared with $125 billion in all of 2009. Corporations are using debt to pay for buybacks after the average yield on U.S. investment grade bonds fell to an all-time low of 3.70 percent last month, data from London-based Barclays Plc show.
Companies from Microsoft Corp. to PepsiCo Inc. and Hewlett- Packard Co. are taking advantage of low-cost financing, purchasing their stock to boost per-share earnings at a time when the Standard & Poor’s 500 Index trades at a 24 percent discount to its average valuation since 1954......
“It’s so cheap to do it now in the bond market: issue debt, fix their cost of capital, then shrink the number of shares outstanding,” said James Swanson, chief investment strategist at Boston-based MFS Investment Management, which oversees about $197 billion. “The markets are almost calling for them to do it.”It seems the corporate cfos still remember what they learned in corporate finance class with regards to cost of capital even if individual investors don't quite understand risk and reward on bond investments,
Buybacks let firms boost per-share profits by reducing their equity base and may indicate executives find their stock undervalued. .....
....“Oftentimes, you’ll see a debt issuance almost simultaneously with a share buyback announcement,” said Guy Lebas, chief fixed-income strategist and economist at Janney Montgomery Scott LLC in Philadelphia. “Even though there’s no explicit connection, it only takes a little bit of common sense to realize the relationship.”....
In fact this pattern of cheap debt issuance paired with stock buybacks may be the explanation of the stock market's recent rally without any real improvement in the overall economic outlooks:
Announced buybacks this year are about 70 percent below the record $863 billion pledged in 2007, Birinyi data show. While the S&P 500 trades at 12.4 times forecast earnings for the next 12 months, compared with a 56-year average of 16.4 times reported profit, low valuations haven’t been enough to spur an equity rally.
The S&P 500 rose 1.5 percent to 1,142.71 today, the highest level since May 13. It’s up 2.5 percent in 2010 and down 6.1 percent from its April high. The index gained 1.5 percent last week amid speculation Microsoft will sell debt for share buybacks and after Oracle Corp. beat earnings estimates.
corporate finance 101: when raising capital through debt is cheaper than raising it through equity...issue more bonds. :
Decreasing price-earnings ratios and record low interest rates are spurring executives to raise money in credit markets. U.S. companies have sold $83.4 billion in new stock in 2010, the lowest level for the first nine months of any year since 2005, based on data compiled by Bloomberg. At the same time, companies sold $786 billion in both high-yield and investment-grade U.S.- dollar denominated debt after $1.23 trillion last year.
“Corporations are finally feeling a little bit more comfortable and realizing that their own shares are cheap and financing is very cheap, so why not issue some debt and buy back stock?” said David Kelly, who helps oversee about $445 billion as chief market strategist for JPMorgan Funds in New York. “That’s a great way of distributing cash to shareholders and boosting stock prices.”
...The demand for bonds has allowed some of the riskiest borrowers to sell bonds with fewer protections for investors. These provisions, or covenants, prevent companies from taking actions that would hurt bondholders and would protect investors if companies are sold.