06 Dec

Stocked Up on Supply & Demand

It has been beneficial to own equities during the past few years—especially in 2013. Whether it stems from increased earnings, expanding multiples, quantitative easing or the continued rotation away from low interest–bearing fixed-income, equity investors have seen the value of their holdings increase.

We offer another explanation for why the US stock market continues to rise: the basic economic concept of supply and demand. For many years there has been a significant increase in share buybacks by companies. The data illustrate a general trend.

During the past 10 years, the raw number of total outstanding shares from companies in the Russell 1000 Index (the 1,000 largest companies in the US) actually declined in spite of the increase in the total size of the economy. It is important to realize that the composition of the index changes year to year. In addition, nearly 100 companies no longer exist from 10 years ago and the index frequently adds new companies.  Interestingly, during this time period the capitalization (or market value) of the index increased from $11.3 trillion to $19.3 trillion, a 41% percent jump, according to Bloomberg.

How does this happen? Bankers—and their clients—arranged far more mergers and acquisitions in recent years than initial public offerings or sales of additional shares. This tipped the balance toward reducing available shares instead of putting more into circulation.

Equities (broadly defined) showed tremendous strength in the past five years subsequent to a near global economy collapse. In the last half of 2013, equity returns were stronger than the underlying economic activity would seem to indicate. One explanation might be the convergence of a dwindling supply with increasing demand for publically traded stock. (This was further exacerbated by central banks’ printing presses—see previous blog posts (http://www.epiqpartnersllc.com/blog/item/59-the-punch-bowl-going-away?-not-so-fast)).

Companies are more productive today, while at the same time the cost of debt declined with record low interest rates. This creates businesses that produce high levels of profits and cash flows. Taken alone this can explain why the broad-based US markets are near all-time highs. With modest economic growth anticipated for 2014 and beyond, businesses with record profits and strong balance sheets are investing adequately into research, plant and equipment. However, they still have excess cash to deploy into acquisitions or return to shareholders. With a slow-growing economy, one strategy might include continued buybacks of additional stock, which could further reduce the share count.

There are many Minnesota-based companies following this game plan, including 3M, Patterson Companies and MTSC to name a few. During the past decade, retailer Target Corp. has reduced its share count by 29% while growing its top and bottom lines significantly. Earnings nearly doubled to $3 billion during this period and earnings per share increased from $1.81 to $4.52 or 150%.

Just this week, tractor manufacturer Deere & Co. announced an $8 billion share repurchase plan representing 25% of the company’s stock at current prices. This is on top of its 22% reduction in shares during the past 10 years.

At the end of the day, we might not experience robust growth in the economy in the near term. But investors still might see constructive returns thanks in part to shrinking share counts. 

***

Join us in welcoming Michelle Boisselier to the EPIQ team.  Michelle comes to us with an outstanding background in office management, client service and entrepreneurship. She is a fantastic addition to the team and vital to our growth and commitment to outstanding levels of service.  We were seeking an true utilitarian – found one - and are excited to have Michelle aboard.

Enjoy the holiday season!

 

Newsletter

Contact Us

2919 Knox Avenue South, Suite 200
Minneapolis, MN 55408

612.843.4800 office

EPIQ Partners is committed to building long-lasting relationships

Our managing partners believe client intimacy and professional advocacy are what makes this firm special and different from other investment firms. We bring a partnership approach to all of our relationships.

We offer a retainer-based, fee-for-service model to ensure the highest level of transparency and alignment.