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March 11, 2014

How investors may be getting fooled by buybacks

NEW YORK — NEW YORK (AP) — If you're puzzled why the U.S. stock market has risen so fast in a slow-growing economy, consider one of its star performers: DirecTV.

The satellite TV provider has done a great job slashing expenses and expanding abroad, and that has helped lift its earnings per share dramatically in five years. But don't be fooled. The main reason for the EPS gain has nothing to do with how well it runs its business. It's because it has engaged in a massive stock buyback program, halving the number of its shares in circulation by purchasing them from investors.

Spreading earnings over fewer shares translates into higher EPS — a lot higher in DirecTV's case. Instead of an 88 percent rise to $2.58, EPS nearly quadrupled to $5.22.

Companies have been spending big on buybacks since the 1990s. What's new is the way buybacks have exaggerated the health of many companies, suggesting through EPS that they are much better at generating profits than they actually are. The distortion is ironic. Critics say the obsessive focus on buybacks has led companies to put off replacing plant and equipment, funding research and development, and generally doing the kind of spending needed to produce rising EPS for the long run.

"It's boosted the stock market and flattered earnings, but it's very short term," says David Rosenberg, former chief economist at Merrill Lynch, now at money manager Gluskin Sheff. He calls buybacks a "sugar high."

Over the past five years, 216 companies in the S&P 500 are just like DirecTV: They are getting more of a boost in EPS from slashing share count than from running their underlying business, according to a study by consultancy Fortuna Advisors at the request of The Associated Press. The list of companies cuts across industries, and includes retailer Gap, supermarket chain Kohl's, railroad operator Norfolk Southern and drug distributor AmerisourceBergen.

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