President Donald Trump's late-2017 tax cuts showered U.S. corporations with a cash windfall, and many CEOs opted to use that cash to buy back a record amount of their own stock, a financial-engineering tactic that's commonly used as a quick way to juice earnings per share.
But according to a report Monday from analysts at Bank of America, the efforts were also fueled by debt: Companies borrowed money by taking out loans or selling bonds, and then used the fresh capital to pay for the stock buybacks.
And now, the debt has to be repaid implying that stock-market investors might not see similar earnings-per-share gains this year, despite a year-to-date rally of 16% in the S&P 500.
Over the past five years, U.S. companies have bought back $2.7 trillion of their own shares and paid out $3.3 trillion in dividends, but they've taken on $2.5 trillion of additional debt, the bank's analysts wrote.
And the tactic has helped: Some 30% of average growth in earnings per share has come from stock buybacks.
"Buybacks have been seen as the savior of a lackluster profits cycle," according to the analysts.
But turmoil in corporate bond markets in late 2018 provided a "wake-up call" that is now prompting some CEOs to rethink the strategy, according to Bank of America, if they want to avoid having their bond ratings cut to junk grade by credit-analysis firms like Standard & Poor's and Moody's Investors Service, and then face unpleasant headlines along with the likelihood of higher interest costs in the future.
"Today, the game has changed," according to the bank. "Three times as many investors want companies to pay down debt than to buy back stocks."
Average earnings per share for the S&P 500 will increase by just 7% in 2020, following an anemic growth rate of 4% this year, the Bank of America analysts predict.
Last year's record $806 billion of S&P 500 stock buybacks helped juice average earnings per share by an estimated 21%.
For stock investors, there's now a growing risk that companies might start using their cash to pay down debt -- and possibly even issuing new shares to cover the cost.
"After years of transferring value from bondholders to shareholders, companies may now be forced to instead defend their balance sheets at the expense of shareholders," the analysts wrote.