Source: Federal Reserve, Schroders. Data to 2019.

Corporate purchases have been driven by a combination of buybacks and mergers and acquisitions (M&A), with a roughly 50/50 split of each. However, both are likely to dry up soon. Buybacks in the final quarter of 2019 were already down 20% from a year earlier and M&A activity has fallen by 51% in the first quarter of 2020, the worst annual fall since 2008. If these trends continue, the market drawdown could be exacerbated and delay the recovery in equity markets.

The main issue with this framing is that it disguises which companies have been doing most of the buying. For example, the 500 largest US companies spent $3.2 trillion on buybacks over the last five years, according to data from S&P Dow Jones.

Yet the top 20 companies accounted for nearly a third of this total and Apple alone accounted for 8%. A more nuanced analysis shows that the net effect of removing buybacks will be most felt in a handful of sectors and companies.

Which sectors are most vulnerable in a world of no buybacks?

EPS is equal to net income divided by the number of shares outstanding. As a result, if EPS grows faster than net income, this must mean a net reduction in the number of shares outstanding (buybacks exceeded share issuance). If EPS grows slower than net income, this must mean a net increase in shares outstanding (share issuance exceeded buybacks).

Over the past five years, the gap between annual EPS and net income growth was around 1% for the average S&P 500 company. In other words, net buybacks boosted EPS by only 1% each year. To put this into context, the annualised total return of the S&P 500 was 11% over the same period. So despite all the hype about buybacks, they have been fairly insignificant for the average stock. This revelation may come as a surprise but it is backed up by academic evidence.

Nevertheless, the distribution of this effect has been highly uneven. In certain sectors and companies it has had a significant impact (see chart). In these cases, buyback suspensions could weigh heavily. Consumer discretionary and industrial stocks are most at risk.

On average, they have boosted their annual EPS growth by 4.5% and 3.7% a year, respectively. Ironically, these industries are also more likely to cut buybacks given their sensitivity to travel restrictions and plummeting consumer demand.

In contrast, buybacks have had little impact on more defensive areas of the market such as consumer staples and healthcare. They look less vulnerable from this perspective. On the other side of the scale, companies in a number of sectors have been net issuers of shares over the past five years so have received no boost from buybacks (the opposite, in fact).

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