Answering Questions; Presenting Conclusions: continued
Capital Flows in Context
How Capital Flow Analysis Answers Questions
The relationship between equity prices and corporate buybacks is long standing.
In fact, corporations have been engaged in buyback programs since the early eighties, driving stock prices upwards for two decades.
Therefore, if we want to answer the questions about the possibilities of continuance of the buyback movement, we need to examine the relationship between profits, dividends, and buybacks at least as far back as the early 1980s.
The information we need can be found in sector flow table F.102 (Nonfarm Nonfinancial Corporate Business).
Looking at this table, we find data on:
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Corporate profits before tax (line 1)
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Net dividends (line 3)
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Net buybacks (the negative values in line 37)
The Federal Reserve has this data available as far back as 1945 in PDF format in the historical data section.
This historical data is not in a user friendly format, but you can download the data in Excel spreadsheet format from Freelunch.com, after registering. (Note: If you don't have Microsoft Excel, you can use the spreadsheet that comes with the free software package, Open Office.)
Using spreadsheet software, we can sum the data series for dividends and buybacks, compare the total with before-tax profits, and draw a chart showing the relationship between dividends and buybacks as a percentage of pretax profits since 1952.
When we are finished, we have a graph that looks like this:
The red line shows total dividends and buybacks as a percent of before tax corporate profits.
We've plotted a polynomial trend (in black) against these points to facilitate our view of the trend.
We note that the percent of profits distributed as dividends and buybacks fell from about 60% in 1952 (mostly dividends) to a low of 20% in 1985, rising thereafter and reaching 90% (mostly buybacks) in 1999.
Strengthening Conclusions
We now have the facts needed to counter the argument that buybacks can go on forever:
- By 1999, 90% of corporate profits were being paid out as dividends and buybacks, but mostly as buybacks;
- The trend of combined dividend-buyback pay-outs has risen from about 20% of pre-tax profits in 1985 to 90% of pre-tax profits in 1999, while stock prices have been driven progressively higher;
- The natural limit for total payout is 100% of profits and this limit is rapidly approaching;
- As prices get higher relative to earnings, it takes larger and larger buybacks to have the same effect on prices;
- As it gets more expensive for corporations to use buybacks to drive up prices, companies will begin to run out of cash to use for this maneuver;
- Therefore, it is not reasonable to expect corporations to be able to drive up stock prices indefinitely by using buybacks.
By anticipating this objection to a thesis that equity prices might suffer a reversal in 2000, we have not only made our argument more convincing but we have strengthened our convictions, which is particularly valuable when taking a contrarian view in the midst of a bull market.
Presenting Results
Three samples of Capital Flow Analysis are published on this web site for educational purposes:
- The equity market;
- The bond market; and
- The residential real estate market.
The form and forum in which you present your opinion of market trends may vary widely, from a written article, to a speech, to a comment at a meeting of portfolio managers, to an opinion given to a client.
In any case, lest you lose your audience, your presentation should be brief and in as simple language as you can muster.
The Capital Flows Forum, on this site, offers you an opportunity to test your ideas anonymously, before real audiences, receiving criticism and comments without putting your job or relations with clients at risk.
If you have developed an example of Capital Flow Analysis of which you are particularly proud, you can also submit articles to the Capital Flow Watch weblog, for RSS publication to a world-wide audience.
The forum and the weblog are intended to supplement the educational tools on this site, serving as a free laboratory for students of Capital Flow Analysis to test skills, without endangering careers or reputations.
Before proceeding, check your progress:
Self-Test
Federal Reserve flow of funds accounts extend back as far as:
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The rate of corporate stock buybacks is most likely to slow down because :
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You can test forecasts based on Capital Flow Analysis without endangering your career by:
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