Goldman Thinks European Stocks Are Harboring A Secret Weapon

Goldman Thinks European Stocks Are Harboring A Secret Weapon
Carl Hazeley

over 1 year ago4 mins

  • Investors like companies that buy back their own shares because they usually boost the stock price, they’re a show of confidence, and they’re tax-efficient.

  • Goldman Sachs believes that high cash balances, low dividend payouts, and a lack of incentive to invest elsewhere mean European companies will up their share buybacks.

  • Commodity-related sectors, financials, healthcare and technology firms are potentially best-placed to deliver on the buybacks.

Investors like companies that buy back their own shares because they usually boost the stock price, they’re a show of confidence, and they’re tax-efficient.

Goldman Sachs believes that high cash balances, low dividend payouts, and a lack of incentive to invest elsewhere mean European companies will up their share buybacks.

Commodity-related sectors, financials, healthcare and technology firms are potentially best-placed to deliver on the buybacks.

Mentioned in story

Goldman Sachs has some good news: the investment bank thinks the percentage of European companies buying back their own shares could reach an all-time high this year, and that they’ll spend more on buybacks too. And since investors often reward companies that do exactly that, let’s look into which of them might be poised to put their money where their shares are.

Why is Goldman expecting buybacks to rise?

1. Companies have a lot of cash.

European companies are holding onto a record amount of cash, which suggests there’s scope for buybacks to pick up. That’s especially true in commodity-related sectors, where they’re generating a lot of cash right now, and in financials, where there’s arguably little incentive to invest elsewhere right now.

2. Dividend payouts are low.

The 12-month forward per share dividend level of European stocks is back at pre-pandemic levels, but the “payout ratio” – that is, the dividend paid as a percentage of company earnings – has dropped off.

Source: Goldman Sachs.
Source: Goldman Sachs.

That’s a good reason for companies to up their buybacks, since they give them more flexibility than dividends: the latter generally lead to a precipitous share price drop if they’re cut, while buybacks are seen as an infrequent “bonus dividend” that can be cut back without negative effects.

3. Companies aren’t investing.

The amount companies are investing in themselves for the long-term (known as their capital expenditure or “capex”) as a proportion of their annual free cash flow is at an all-time low in Europe, even if you include ongoing research and development costs.

Source: Goldman Sachs.
Source: Goldman Sachs.

Investors have rarely rewarded companies that have upped capital expenditure, so there’s arguably not much incentive to spend in that way. But they have rewarded companies that buy back shares, making that a more appealing use of cash.

4. Valuations look attractive.

The STOXX 600 – Europe’s key index – currently trades at a price-to-earnings ratio of 12x. That’s its 20th percentile over the last decade, meaning it’s almost as cheap as it’s ever been in the last 10 years. Consider too that analyst profit estimates have increased for almost every sector in Europe despite the global growth slowdown, suggesting things mightn’t be as bad as some investors think. That creates an opportunity for companies to buy back their own shares, which creates ongoing demand for them. So while the stock market may continue to fall, those of companies that are buying back their own shares should – all else equal – fall by less.

5. Insiders are buying.

Goldman’s tracker of insider activity has reached an all-time high, meaning executives within major companies are buying the dip.

Source: Goldman Sachs.
Source: Goldman Sachs.

Insiders are often paid partly in stock, which they need to sell in order to access their cash. That means they historically sell more company shares than they buy. But recently, buying has outstripped selling, which suggests insiders don’t think the outlook is as bad as investors do. And if insiders – which include company CEOs and CFOs – are buying stock for themselves, it stands to reason they might buy back stock with the company’s own cash too.

So what’s the opportunity here?

First, the catch. It’s worth keeping in mind that there are two key reasons Goldman’s prediction might not come to pass.

For one thing, companies prioritize the stability and resilience afforded by hoarding cash in the face of ongoing uncertainty. If that’s the case, buybacks would probably be on hold or much reduced until companies feel more confident about the future, or until they feel they have a big enough buffer. And second, companies might actually end up deciding to spend their cash on capex: high inflation could encourage companies to spend more now, or else risk paying more in a year or two’s time.

But like we say, there are still plenty of incentives for them to buy back their own shares. And industries where the incentive to invest in themselves is low – commodity-related sectors and financials – or where companies have a lot of extra cash – healthcare and technology – are likely to lead the charge. Regionally, UK companies might be set to ramp them up given their high free cash flows relative to company size, as well as their high aggregate exposure to commodities.

Goldman also published a list of companies it believes could announce more buybacks, based on their valuation, dividend payout ratio, cash and debt levels, cash flows, historical buybacks, and earnings forecasts. The biggest names include energy giants Shell, Total, and BP, consumer firms L’Oreal and Kering, healthcare titans Novartis and Sanofi, and banks HSBC and UBS.

STOXX 600 companies that could announce more buybacks (part 1). Source: Goldman Sachs.
STOXX 600 companies that could announce more buybacks (part 1). Source: Goldman Sachs.
STOXX 600 companies that could announce more buybacks (part 2). Source: Goldman Sachs.
STOXX 600 companies that could announce more buybacks (part 2). Source: Goldman Sachs.
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