Double counting / Hussman

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Unfortunately, investors are currently engaged in wild-eyed double counting, imagining that higher per-share earnings figures and higher repurchases are separate effects, when they are one in the same. The truth is that a significant portion of the higher per-share figures is the result of repurchases, and the higher repurchases are the result of a paucity of alternative uses for the cash.

To put some numbers on this, Bill Hester notes that according to Bloomberg, among S&P 500 companies reporting to-date, the average surprise on operating earnings (cough) per-share has been 9.66%, while the average surprise on operating earnings on a total dollar basis has been 5.85%. Of course, the average is skewed by a few extreme outliers (for example, Hasbro reported operating EPS of 19 cents, versus an estimate of just 1 cent). The median surprise, which is a more robust measure, has been 2.94% in operating earnings per share, and just 1.93% in operating earnings themselves

It is wrong to hail an increase in per-share earnings as if it is an “earnings surprise” – as if it reflects an improvement in corporate operating conditions, when it is in fact an expenditure of existing earnings on shares instead of on business investments. When such repurchases are done at rich valuations, they are a signal that the company lacks other productive business opportunities and is instead propping up per-share earnings by disposing of what it does earn.

Why haven't investors figured this out? The story constantly repeated on CNBC is that companies low-balled their earnings guidance in order to surprise investors with better than expected earnings (with the implication that the market will rise forever because companies can continue to do this indefinitely). A good part of the true story is that analysts made their forecasts of per-share earnings based on old, higher share counts, so the juiced per-share figures resulting from repurchases are now showing up as “earnings surprises.”

As Standard & Poors itself warned last year,
“S&P has concern as to the extent that some equity analysts incorporate share changes into their analysis. If a higher share count is used in the calculation of an estimate, the result would be an under estimation of the EPS. This could lead to an initial assumption of a positive earnings surprise when the actual EPS is announced, since the announced value is higher than the estimated value. The discovery that the variance is due to share change, however, would not take long, resulting in any initial upward price movement being negated.”