Recent volatility in global equity markets has led to an uptick in bearishness among investors, according to a survey released recently by The Boston Consulting Group (BCG).
The survey—conducted in early 2016 by BCG in partnership with Thomson Reuters—finds that investors are more bearish—at least about the near term. Thirty-two percent of respondents described themselves as either “bearish” or “extremely bearish” about equity markets in 2016—a nearly 70% increase from 2015 and the highest percentage since 2009, during the financial crisis.
The respondents’ bearish sentiment is reflected in their estimate for TSR: 5.5% annually over the next three years, the lowest estimate since we began conducting the survey and considerably below the S&P 500 90-year average of 10.1%. (TSR measures the combination of share price gains and dividend yield for a company’s stock over a given period. It is the most comprehensive metric for performance in shareholder value creation.)
At a time when share buybacks are reaching record heights, respondents believe that most of the TSR in the next three years will come from cash payouts (both dividends and buybacks). But investors don’t believe that payouts alone will deliver superior performance. They put a higher priority on other uses of a company’s excess cash, especially growth-oriented investments.
In an environment characterized by modest GDP growth, near-record levels of profitability, and high valuation multiples, investors appear to be seeking companies with credible strategies for value-creating growth. They are increasingly interested in companies that are using cash for strategic M&A and those with experienced management teams and compelling equity stories based on strong fundamentals and intelligent capital allocation.
Putting the Findings into Context
Some background helps put these findings into context. In 2015, nonfinancial companies in the S&P 500 returned more than a trillion dollars to shareholders—share buybacks made up over 60% of the total, and dividends accounted for the rest. Buybacks have increased more than fourfold since 2009, accounting for roughly 3% of the average 8.5% growth in earnings per share. By contrast, capital expenditure budgets in the S&P 500 have grown only 44% over the same period.
“After a period in which companies returned record amounts of cash to shareholders, investors appear to be looking for companies to use that cash to improve the fundamental value of their businesses,” said Jeffrey Kotzen, a BCG senior partner and global leader of the firm’s Shareholder Value practice.
The findings also need to be understood in the context of companies’ ongoing adjustment to a macroeconomic environment that, since the 2008–2009 global financial crisis, has been characterized by relatively low growth. “Companies have cut costs to improve profitability and free cash flow, taken advantage of low or even negative interest rates to increase leverage, boosted payouts in the form of dividends and share buybacks, and benefitted from valuation increases as capital markets have rebounded from their post-financial-crisis lows,” said Frank Plaschke, a partner in BCG’s Munich office.
The findings of the BCG survey, however, suggest that investors believe that these strategies have largely played themselves out. “Margins are currently at or near their peak, making additional improvements increasingly difficult,” said Tim Nolan, a partner in the firm’s New York office.
“Returning cash to shareholders will continue to constitute a large percentage of TSR, on average, and provide a floor for valuation; but cash payouts alone won’t deliver superior value. Finally, although interest rates have been low, they are likely to increase in the near future. All these factors mean that valuations will likely be under continued pressure.”
In such an environment, investors want companies to focus on improving their fundamental-value engine: to put in place the managerial vision, organizational capabilities, and capital investments necessary to create a strong foundation for growth in the core business. “In a low-growth environment, this is an enormous challenge,” said Kotzen. “But precisely because of this difficulty, delivering value-creating growth will likely be what distinguishes the superior value creators from the rest.”