Good news for investing in stocks. Goldman Sachs believes the percentage of European companies that will buy back their own shares could reach an all-time high this year. As investors tend to reward companies that distribute dividends, let's see where to place our investment in European stocks now that earnings season begins.
Why does Goldman expect buybacks to rise in stock investing?♻️
Companies have a lot of cash
European companies are hoarding a record amount of cash. We can interpret that there is room for buybacks to increase. For example, in sectors related to investment in energy stocks, where they are generating a lot of cash right now. Also in investing in stocks in the financial sector, where there is arguably little incentive to invest elsewhere at the moment.
Dividend payments are low
The 12-month forward dividend per share level of European equity investment has returned to pre-pandemic levels, but the «payout ratio"(the dividend paid as a percentage of the company's profits) has fallen.
Dividend per share (DPS) and payout (RHS) ratios for the last 17 years.
Source: Goldman Sachs
This is a good reason for companies to increase their buybacks, as it gives them more flexibility than dividends. The latter often cause a precipitous drop in share investment if they are cut, while buybacks are considered a rare "extra dividend" that can be cut without negative effects.
Companies are walking on eggshells⚠️
The number of companies that are investing in themselves for the long term as a proportion of their annual free cash flow (known as "Capex«), is at an all-time low in Europe, even if we include ongoing research and development costs.
Growth ratio in investment in shares. Source: Goldman Sachs
Investors have rarely rewarded companies that have raised capital spending, so arguably there isn't much incentive to spend this way. However, companies that buy back shares have been rewarded, which makes this a good incentive to invest in shares.
Equity investment valuations look good
El STOXX 600, the leading European index, is currently trading at a price-to-earnings ratio of 12 times. This means it is almost as cheap as it has been in the last 10 years. It should also be noted that analyst earnings estimates have risen for almost all equity investment sectors in Europe despite slowing global growth. This suggests to us that things might not be as bad as some investors think. This opportunity for companies to buy back their own shares creates continued demand for them. Therefore, although the stock investment market continues to fall, investment in stocks of companies that buy back their own shares should, other things being equal, fall less.
Insiders are investing in stocks
Goldman's tracker of insider activity has hit an all-time high, meaning investors in major companies are buying the dip.
Insider Investor Activity Index. Source: Goldman Sachs
Insider executives often receive part of their salary in stocks, which they need to sell to access their capital. This means that historically they sell more shares of the company than they buy. However, stock investment has outpaced sales lately, suggesting that executives don't believe the outlook is as bad as investors do. And if insiders (company CEOs and CFOs) are investing in shares for themselves, it is logical that they also buy back shares with the company's own capital.
How do we take advantage of this investment opportunity in European stocks?
Everything seems very nice, but we must tread carefully. Keep in mind that there are two key reasons why Goldman's prediction might not come true:
- Companies prioritize the stability and resilience provided by accumulating cash in the face of continued uncertainty. In this case, share buybacks will likely stay as they are or be reduced until companies feel more confident about the future.
- Companies could end up deciding to spend their cash on capex: High inflation could encourage businesses to spend more now, or risk paying more in a year or two.
But, as we say, there are still many incentives for investing in stocks. And the sectors in which the incentive to invest in shares of their own companies is scarce. Sectors related to raw materials and the financial sector or where companies have a lot of cash (healthcare and technology) are likely to lead the charge. Goldman has also published a list of companies it believes could announce more buybacks, based on their valuation, dividend payout ratio, cash and debt levels, cash flows, historical buybacks and earnings forecasts. Top names include energy giants Shell, Total and BP, consumer companies L'Oreal and Kering, healthcare titans Novartis and Sanofi, and banks HSBC and UBS.