Q: Do stock buybacks increase companies' profit?
A: Companies are going crazy buying back their own shares. And these buybacks create the mirage that earnings per share are rising. Savvy investors know how to look beyond this distortion.
Members of the Standard & Poor's 500 boosted the amount they spent buying back their own stock by 30.5% in the fourth quarter of 2013 versus the same year-ago period, says S&P Dow Jones Indices.
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In a positive development for investors, while companies were busily buying back stock, they didn't issue new shares as rapidly. The result? A major bump to earnings per share.
This happens because companies' net income is being cut into fewer slices. The effect is profound now. More than 100 stocks in the S&P 500 reported earnings per share growth that was 15% higher than net income growth last year, says S&P Dow Jones Indices.
But will the changes in share counts distort the profits reported by the entire S&P 500, the basis for many mutual funds and exchange-traded funds? No, says Howard Silverblatt of S&P Dow Jones Indices. The S&P 500 changes the weight holdings to adjust for changes in the shares outstanding. Doing so allows investors to more accurately measure how fast earnings are growing from year to year.
It's a different situation with the Dow Jones industrial average. The Dow is weighted by per share data. When a company has a decrease in the number of shares, which boosts earnings per share, the Dow's measured profitability will rise.
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