In the great buyback binge of 2009-16, equity investors have learned to cheer company stock buyback announcements. With each buyback, it seems, there is more support for a continuing market rally, and individual companies often get a short-term stock price boost. However, it may be time to help investors reduce their expectations for what buybacks can do, using these points.

Buybacks work best when earnings are strong, stock prices are depressed, and P/E ratios are below-average. Companies can use operating earnings to boost the stock price and reward investors. (Alternately, they can do the same by declaring higher dividends.)
Buybacks may not work well when companies increase leverage (i.e., borrow money) to purchase their own shares – especially when earnings are declining, stock prices are high, and P/E ratios are above average. These conditions now exist for the U.S. stock market as a whole.
For the stock market, buybacks run in cycles – typically peaking just before market declines. In the last market cycle, buybacks of S&P 500 components increased from an annualized rate of $150 billion in 2004 to a peak of $680 billion in mid-2007, before falling back to the $100 billion level in 2009. Many companies bought back their stock at high prices and then had to sell new stock (to raise capital) at far lower prices. Buybacks often have been poorly timed corporate investments.
Buybacks are fueled by low interest rates, and they cause the whole stock market to "lever up," which increases volatility and makes the market more vulnerable at the point in a cycle when buybacks dry up – because earnings are declining while the cost of corporate credit starts to rise.

You can see these points, and show them to your clients, in a set of charts Yardeni Research has published online, through the first quarter of 2016.

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What to tell clients about stock buybacks

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