Donald Trump managed to close out his first year in the White House with a major tax reform package that had something for everyone, except for homeowners in deep-blue states, but most especially for investors. Among the highlights that have them so excited is a tax holiday allowing for repatriation of overseas cash. Investors are hoping that cash is used for more dividends and buybacks, but a safer bet could be on another round of merger mania.
Given how much capital has been returned to shareholders over the last few years, it’s understandable why the market might be expecting all that overseas cash to help boost shareholder yield. The amount of money spent on buybacks has dipped slightly from the highs of 2016, but the S&P 500 components alone have paid out more than $500 billion for the four quarters ending last September. Add in more than $400 billion in dividends and the firms that make up the S&P 500 returned close to $1 trillion in capital, so why would “buyback fever” not be a sure thing?
It starts with the expectation that not all that overseas cash is coming home, at least that’s what Goldman Sachs (GS) thinks according to a recent report. They estimate that members of the S&P 500 have more than $920 billion in cash overseas, the bulk of which is held by tech and healthcare names, but expect that only $250 billion of that will be repatriated, in line with what happened the last time there was a tax holiday in 2004. Even if 100% of that amount was applied to buying back shares, that would only represent two quarters of extra payments based on 2017’s figures. Then consider the case of the largest buyback exchange-traded product, the PowerShares Buyback Achievers Portfolio (PKW), which our quantitative models currently give a weak Green Diamond score of 3.4 out 10.
PKW may have outperformed the broader market in December as hopes for tax reform began to firm, but the fund lagged slightly behind the broader market for 2017. Why the lackluster performance? Consider who’s been buying back the most shares. PKW is designed to offer exposure to stocks that have seen their outstanding shares drop by 5% or more over the prior 12 months when the fund is reconstituted in December. Seems straight forward, but soaring prices for many cash-rich tech stocks make it difficult to hit that 5% threshold no matter how well funded the campaign.
Mighty Apple (AAPL) has taken on substantial debt and managed to trim its outstanding shares by nearly 20% over the last four years ending in 2017 with $44 billion remaining on its buyback plan. But based on the prices at the end of December, that amounted to less than 5% of shares outstanding. Instead, PKW is overweighted in consumer discretionary and industrial names that often see buybacks as the easiest way to boost EPS.
Investors hoping for a big payday don’t despair and instead cast your eyes further afield at healthcare names that hold the second largest pile of overseas cash including Pfizer (PFE), Merck (MRK) and Amgen (AMGN.) All are well represented in most healthcare funds, but one possibility is that their overseas cash might be used to increase EPS the old-fashioned way, through acquisitions, in which case investors should keep an eye on biotech funds instead.
Two standouts are the iShares Nasdaq Biotechnology ETF (IBB) and VanEck Vectors Biotech ETF (BBH), both of which have Green Diamond scores north of eight thanks to a combination of strong price momentum and low earnings multiples (see “Likely tax winner”). Both also have large positions in those cash-rich names we mentioned earlier, potentially offering a boost if they do pursue a buyback or dividend, along with a host of smaller names that could be acquisition targets to help boost EPS.