Because of historically low interest rates, companies are selling bonds (borrowing money) and buying back shares.  This is a good thing for the market, but is it just a short-term sugar high?

Let’s look at some figures.  For the twelve months ending March 31, 2014, companies increased the amount of company shares they purchased by 29% to a value of $534 billion.  This is the second highest amount since 2007 when buybacks totaled $589 billion.  And while we did say that share buy backs can be good for the stock market, the issue that is disconcerting is that most of the purchasing was done with borrowed funds.  Partly as a result of this borrowing, net US corporate debt rose 14% last year to a record $2.3 trillion.  Even conservative companies that usually avoid debt such as Bed, Bath & Beyond are joining the fray.  It just announced a bond deal that will raise $1.5 billion and it plans to use those proceeds to buy back shares.  When sales are declining (see below chart), financial engineering is one way to make corporate results look better on a short-term basis.  Why is this bad?

On the surface, it looks like buybacks are always good for company shares.   Why not sell bonds with an interest rate of 2% or less and buy back company shares?  Short-term, that seems like a good idea.  The problem is that those bonds will mature at some point and have to be paid off.  If rates rise (which is a good possibility over the next few years), a company will have to issue new bonds at a higher rate of interest to pay off the maturing bonds.  If interest rates rise too high, a company also can raise cash by issuing shares of the company (a little ironic to issue new shares to pay off bonds that were originally used to buy back shares!).  Either way, future earnings will suffer.  Will the hangover of future lower earnings justify this short-term high?

Interesting fact – The median annual cost of a private medical education is $71,702 a year.

Source: MarketWatch.com