For many years, corporate bonds have been a stable source of finance for many U.S. companies. Bonds are the central market mechanism used to create and expand businesses. This efficient, market-driven process, when unhindered by government intervention, produces the desired effect of economic growth.
Multinational corporations have been going into serious debt, raising substantial amounts of capital by selling corporate bonds to investment firms. For example, as of 08/2017, Apple’s corporate bond debt was $5.5 billion. As of 06/2017, Microsoft’s debt was $86.2 billion. Amazon’s was $7.7 billion.
Lately, the multinationals have been using the capital raised from bond sales to buy back their stock. According to the S&P Dow Jones Indices, in the 12-month period ending on 03/2016, multinational corporations spent a record $589.4 billion on stock buybacks, beating the previous record of $589.1 billion set in 2007. In 04/2016, Apple stated that it was planning to sell $175 billion in corporate bonds to fund their stock buyback program.
The reason the multinationals are undertaking these massive stock buybacks is that the buybacks reduce the supply of outstanding shares available to the firms investing in those companies. As long as their PE ratios remain stable, this strategy will drive share prices higher.
The multinationals also invest significant amounts of capital into dividend payouts. In 02/2016, Apple raised a total of $12 billion in corporate bond sales. All of that capital was paid out in dividends to shareholders.
The payouts attract investors who want to buy the stocks of multinationals with positive earnings expectations in order to receive secure, long-term dividends. The demand created by the generous payouts has resulted in regular share price increases.
The rankings of companies within the S&P 500 index are based upon the component weight of each company. Component weight is the market capitalization of the company compared to the total market capitalization of the S&P 500 index.
As of 05/10/ 2017, the top 4 companies in the S&P 500 by component weight were:
Because these companies are so large, their valuations affect the entire S&P 500 index. As of 08/22/2017, the median PE ratio of the S&P 500 was 14.66 times earnings. The PE ratio of the S&P 500 was 24.65 times earnings. That’s 168% above the median valuation.
As of 08/22/2017, the PE ratios of these companies were all higher than the median valuation of the S&P 500: Apple at 18.11, Microsoft at 27.03, Amazon at 181.41 and Facebook at 42.22.
The four top multinationals’ stock valuations confirm that their dual strategy of buybacks and dividend payouts has worked, enriching the majority shareholders in the process.
If the multinationals continue selling bonds and using the capital to artificially inflate their stock prices, eventually one or more of those companies will be forced to discontinue that strategy. This is because if a multinational continues to borrow money to inflate their stock price, it is inevitable that the borrowing will eventually increase their debt/equity ratio to an unacceptable level and their stock price will take a hit.
When a multinational company reaches the point where it cannot borrow any more money, the continual share price increases of that company will cease. When big investment firms with large stakes in that company realize that their profit window has closed, they will respond by quickly unloading all their stocks and bonds in an attempt to take profits before prices tank.
The failure of just one U.S. multinational company will cause every investment firm to dump all of their multinational stock holdings because all of those companies have artificially high PE ratios.
Here’s a list of the sectors in the S&P 500 with average PE ratios higher than the median valuation:
This data proves how widespread the artificially inflated stock prices of the multinational companies have become, making them all vulnerable to a selloff.
Robert Steven Ingebo, is president of FRI CorporationCommenting Policy
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