Stock Buybacks Can Inflate Earnings, Fooling Investors

Chris Versace

Chris Versace is a financial columnist and equity analyst with more than 20 years of experience in the investment industry.

During the last few weeks, subscribers to my Growth & Dividend Report newsletter have been sitting pretty in the Dividend portion of our portfolio after exiting nearly all of our Growth Portfolio positions in early January. The lone Growth name that we’ve held onto has been PayPal (PYPL), which as you might suspect falls into my Cashless Consumption investing theme, and it’s been nicely profitable since we added it to the portfolio in early September.


Stepping back and looking at the GDR holdings that were added before year-end 2015, they are up 7% since subscribers were advised to add those companies. But that return doesn’t factor in the more than $9 per share in aggregate dividends that were paid out during that time — that’s another 4.5% in return.

Given the current market environment, I bet you’re wondering how the GDR portfolio is holding up year-to-date. I’m pleased to say it is up 3.7% compared to the 5.75% drop in the S&P 500, which means the GDR portfolio is appreciating on both an absolute and relative basis.

With the market rebounding over the last few days, the burning question is when do we start adding back to the Growth side of the portfolio?


It’s a great question, and one not to be taken lightly. After such sharp moves lower in the market like the one we’ve seen through early February, it’s tempting to be a hero and go on a buying spree. If you’ve ever stepped in a puddle thinking it was only so deep and wound up sinking most, if not all, of your entire shoe, then you know that sometimes things are not what they appear to be. After having soaked a shoe or two, I tend to avoid puddles of all shapes and sizes.

One of the key drivers of the rebound has been the surge in companies upsizing their share repurchase programs. When companies buy back their shares, they shrink the shares-outstanding figure we find on the income statement. Such a move leads to more favorable earnings-per-share (EPS) comparisons. Think about it: buying back shares doesn’t change a company’s net income. It just reduces the number of shares that are divided into net income to compute the earnings per share for a given quarter. If you were to think those share buyback programs could help artificially inflate the earnings growth rate, you would be correct.

That’s why even though I examine a company’s EPS growth, I also make sure to look at its net income growth and operating profit growth, as well as trends in its operating margin. If I had to choose just one of those to focus on, it would be trends in the company’s operating margin — sales less cost of goods sold, less selling, general and administrative (SG&A) expenses and research and development (R&D) spending, divided by sales — because they give a good view of how the business is performing. If operating margins are expanding, the company is boosting its profits; if margins are coming under pressure and falling, odds are there is a problem that we as investors need to factor into our thinking.

When thinking about share repurchase programs, which many people like because they mean the company is increasing its skin in the game, be sure to consider the impact on the bottom line and what that means when you’re valuing the shares.


Sorry for my rather lengthy sidebar commentary, but given the rampant buyback activity, I thought it was important to share those details with you.

So, when do we start adding back to the Growth side of the portfolio?

Unlike many people save Warren Buffett, I actually like it when stock prices fall, since it means quality companies are on sale. Who doesn’t love a bargain?

The issue, however, is that growth expectations are being reset. We’ve seen this in GDP forecasts, as well as earnings expectations for the S&P 500. Coming into this week, 2016 earnings expectations for the S&P 500 group of companies had been reduced to $122.42 per share (a 3.7% increase year over year) and I suspect they still have room to drift lower as the remaining 25% of the S&P 500 companies report their results. Remember all those S&P 500 companies with big buyback plans we mentioned a few paragraphs above? Those buybacks mean that a 3.7% year-over-year increase in EPS translates to growth in Net Income slowing, if there’s growth at all.

Despite the market’s rebound during the last few days, much of the economic data we’ve been getting points to further softening in the economy.  For example, the February reading for the Empire Manufacturing Survey from the Federal Reserve Bank of New York came in at -16.6 with continued contractions in new order activity during the month.


This morning, Feb. 17, we received the Fed’s January reading on Industrial Production. While the metrics were up month over month, if you dug into the report, you would have seen that total industrial production was down 0.7% year over year. Moreover, most of the month-over-month strength was due to the jump in utility activity in January. That makes sense and I can attest firsthand to winter’s belated arrival in the latter part of December as I shoveled snow that fell more than 34-inches deep on my driveway.

As long as we continue to get economic data that raises concerns about growth expectations, either for the economy or for a company’s earnings, we’ll continue to sit on the sidelines and collect our dividends as we wait for even more attractive entry points on growth-oriented stocks.

In case you missed it, I encourage you to read my e-letter column from last week where I explain the power of dividends for your portfolio during rocky times. I also invite you to comment in the space provided below.

share on:

Like This Article?
Now Get Mark's FREE Special Report:
3 Dividend Plays with Sky-High Returns

This newly-released report by a top-20 living economist details three investments that are your best bets for income and appreciation for the rest of the year and beyond.

Get Access to the Report, 100% FREE

share on:


Dr. Mark Skousen

Named one of the "Top 20 Living Economists," Dr. Skousen is a professional economist, investment expert, university professor, and author of more than 25 books.

Product Details

  • Forecasts & Strategies
  • Home Run Trader
  • Fast Money Alert
  • Five Star Trader
  • TNT Trader

Bryan Perry

A former Wall Street financial advisor with three decades' experience, Bryan Perry focuses his efforts on high-yield income investing and quick-hitting options plays.

Product Details

  • Cash Machine
  • Premium Income PRO (exclusively for subscribers of Cash Machine)
  • Quick Income Trader
  • Breakout Options Alert
  • Hi-Tech Trader

Jim Woods

Jim Woods has over 20 years of experience in the markets from working as a stockbroker,
financial journalist, and money manager. As well as a book author and regular contributor to
numerous investment websites, Jim is the editor of:

Product Details

  • Successful Investing
  • High Velocity Options
  • Intelligence Report
  • Bullseye Stock Trader
  • Eagle Eye Opener

Bob Carlson

Bob Carlson provides independent, objective research covering all the financial issues of retirement and retirement planning. In addition, Bob serves as Chairman of the Board of Trustees of the Fairfax County (VA) Employees’ Retirement System, which has over $2.8 billion in assets.

Product Details

  • Retirement Watch
  • Retirement Watch Spotlight Series
  • Lifetime Retirement Protection Program

Jon Johnson

Jon Johnson's philosophy in investing and trading is to take what the market gives you regardless if that is to the upside or downside. For the past 21 years, Jon has helped thousands of clients gain success in the financial markets through his newsletters and education services:

Product Details

  • Investment House Daily
  • Stock of the Week
  • Technical Traders Alert
  • Rapid Profits Stock Trader

Used by financial advisors and individual investors all over the world, is the premier provider and one-stop shop for dividend information and research.

Product Details

Popular tools include our proprietary Dividend Calendar, Dividend Calculator, Dividend Score Card, and many more.

  • Dividend Investor

George Gilder

George Gilder is the most knowledgeable man in America when it comes to the future of technology and its impact on our lives.  He’s an established investor, bestselling author, and economist with an uncanny ability to foresee how new breakthroughs will play out, years in advance.

Product Details

  • Technology Report
  • Technology Report PRO
  • Moonshots
  • Private Reserve
  • Millionaire Circle


DayTradeSPY was founded by head trader Hugh Grossman, a retired internal auditor for a Fortune 500 company. After years of first-hand experience trying out one trading strategy after another, Hugh instead developed his own trading system centered around day trading SPY options. That’s it... Nothing else.

Product Details

  • Trading Room
  • Pick of the Day
  • Inner Circle
  • Online Workshops