Companies Binge on Share Buybacks; Share buybacks and dividends are reaching levels unseen since before the financial crisis, as persistent economic uncertainty prompts cash-rich companies to reward shareholders rather than invest in other activities

Companies Binge on Share Buybacks

STEVEN RUSSOLILLO

Dec. 23, 2013 7:13 p.m. ET

U.S. companies are showering cash on shareholders, powering the stock market’s record-breaking rally. Share buybacks and dividends are reaching levels unseen since before the financial crisis, as persistent economic uncertainty prompts cash-rich companies to reward shareholders rather than invest in other activities.U.S. companies in the S&P 500-stock index bought back $128.2 billion of their own shares in the third quarter, according to S&P Dow Jones Indices. That is the highest level since the fourth quarter of 2007.

Combined, stock buybacks and dividends totaled $207 billion in the third quarter, also the highest in nearly six years, according to the data provider.

Among the biggest buyers of their own shares in the third quarter were Apple Inc.,AAPL +3.84%

Pfizer Inc. PFE +0.33% and Exxon Mobil Corp. XOM -0.17% All purchased more than $3 billion of stock in the three months ended Sept. 30. Apple bought back $4.9 billion. Buybacks are good for shareholders and companies alike: They return cash to investors while boosting companies’ earnings per share by reducing their share count.

The big payouts are luring investors to the stock market—bolstering confidence in stocks’ record-setting rally—at a time when other assets such as bonds are offering paltry or negative returns.

But the moves also are cause for concerns for some investors, especially because they come when markets are at records and share valuations are above their historical average.

Some investors are starting to question the popularity of buybacks, saying they would get a better return if companies spend on research and development and on expanding operations.

Burt White, chief investment officer at Boston brokerage LPL Financial, LPLA +1.79%said he expects the pace of buybacks to slow next year, as stocks get more pricey.

“Are stocks cheap here? Probably more like fair value or slightly expensive at this point,” said Mr. White, whose firm manages about $420 billion. “Companies will still need to do something with their cash.” Higher confidence and improved economic growth will probably prompt “companies to spend their cash in a slightly different way,” he said.

Bond investors also are sounding the alarm. In recent years, companies have financed buybacks and dividends by borrowing. This has made some bond-fund managers, who are more concerned with corporate creditworthiness, uneasy.

In a post to Twitter, Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., wrote, “Stocks have their own QE: “corp buybacks” at $500 billion a year. They are a main reason stocks go up. When do THEY taper?”

For the 12-month period ended in September, companies increased buybacks by 15% to $445.3 billion, according to S&P Dow Jones Indices. The high-water market was in 2007: Companies bought $589.1 billion of their own shares that year.

It is unclear what data Mr. Gross was referring to. Mr. Gross wasn’t immediately available for comment. “QE” is shorthand for “quantitative easing,” financial-market parlance for the Fed’s bond-buying program.

Still, investors for now are rewarding companies that execute buybacks.

Companies that are big buyers of their own shares have seen their stock prices outperform the overall market over both the short and long terms.

The S&P 500 Buyback Index, which measures the 100 stocks with the highest buyback ratios, has surged 45% this year, compared with a 28% rally for the S&P 500. The buyback ratio accounts for the amount of cash paid for common shares over the past four quarters divided by the market capitalization of the common stock.

A longer time frame shows an even greater disparity: The Buyback Index is up 27% on a five-year annualized basis, compared with a 19% gain for the S&P 500. These calculations include dividends.

The buybacks also showcase the influence of some activist investors. Apple in April said that it planned to return twice as much cash to investors than previously planned. The disclosure came after months of lobbying by hedge-fund manager David Einhorn. In August, billionaire Carl Icahn began urging Apple to boost its current share-buyback program to $150 billion from the current $60 billion planned through 2015. Mr. Icahn later scaled back his demands, asking for an additional $50 billion.

This month, MasterCard Inc. MA -0.24% approved a $3.5 billion share-repurchase program, as well as a 10-for-1 stock split. President and Chief Executive Ajay Banga said the moves reflect MasterCard’s continuing “commitment to deliver shareholder value as well as our confidence in the long-term growth and financial performance of our company.”