Musings on Economic Growth, Buybacks, and Inflation

We are entering an era of slow growth, especially in the U.S. and Europe. The older demographics and lower productivity are to blame for the low growth. Economic growth was already slow in the 2010s, but artificially low-interest rates from the Fed caused multiple expansions in the stock market. I see these Asset Managers and VCs criticize the Fed and the Government for inflation today, but those guys did not give credit to the Fed and the Government for all the billions they made in profits due to the cheap money policies. Homeowners benefited from the artificially low-interest rates, but most would never call it a hand-out.

Business Insider is reporting that the corporate bond market is in deep trouble. CEOs spent $1 trillion on share buybacks each year to pad their income while their company's balance sheets deteriorated. Oracle spent over 85% of its operating cash flow on share repurchases. Even after all these buybacks, Oracle's stock is way down. No amount of financial engineering can save a company with zero revenue growth.

Oracle can afford buybacks, but many other companies were spending more than their operating cash flow on buybacks and dividends. Essentially, they borrowed money at ultra-low interest rates to fund their buybacks. Even after all these buybacks, Oracle's stock is way down. No amount of financial engineering can save a company with zero revenue growth.

The Biden administration should not bail out corporations for their mistakes and let companies go through the bankruptcy process for the way they mishandled shareholder wealth. We might see a wave of bankruptcies next year (2023). Let's return to our capitalist roots.  It was a mistake to bail out AIG with $170 billion during the 2008 crisis. We spent trillions bailing out corporations for their mistakes in both 2008 and again in 2020.  The US airlines went bankrupt in a week during March 2020.  The US airlines spent all their money on buybacks and had nothing saved for a rainy day. I saw this ad from a Japanese company during the 2020 COVID crisis. They asked applicants to apply to their company and said employees need not worry about getting paid.  They said they have enough money on their balance sheet to pay every employee even if they had zero revenues for 20 years.

Most of the inflation is caused by supply chain disruptions to food supplies and other essentials. No amount of lowering the money supply will reign in inflation caused by supply chain disruptions in food unless we want people to suffer from hunger.

Our problem will be slower economic growth and not inflation a year from now (2023). Inflation will be high compared to the 2010s, but it will settle at a much lower level than its current rate of 6% to 8%. Even this higher level will most likely be due to supply-side challenges. The money supply is already contracting rapidly.

Oracle: Excelling in Financial Engineering.

Oracle (ORCL) faced its first real challenge to its business model from Amazon AWS (AMZN). For a long time, Oracle's relational database has been the standard for many companies in the Global 2000. Oracle's database is still so entrenched in many corporations across the globe that they pay millions of dollars in Oracle license and support fees each year to keep the right to use their software. But, companies formed in the last 10-15 years have shunned the Oracle database. Instead, they have relied on myriad open-source database options and cheaper databases from other companies. The advent of AWS made it easy for any company to manage databases in the cloud. 

Oracle has lagged behind the prominent three cloud vendors in offering infrastructure-as-a-service (IaaS). The company has a reasonably significant market share position in SaaS software, where it competes against the likes of Salesforce (CRM), Workday (WDAY), and SAP (SAP). But, Oracle is still heavily dependent on revenue from its database software. Since Oracle cannot attract new customers to its database, it has resorted to using its existing database install base as an annuity business. In essence, the Oracle database software generates much rental income from its remaining customers.  

In the face of Oracle management's inability to innovate and compete, they have resorted to financial engineering to prop up their share price. A company innovating and competing well in the marketplace is most likely growing revenues. At the very least, revenue growth needs to keep up with GDP growth. Unfortunately, there is no revenue growth at Oracle. In the fiscal year ending May 31, 2011, Oracle had total sales of $35.622 billion. In the fiscal year ending May 31, 2021, Oracle had total sales of $40.479 billion. That equates to a 13.6% growth in revenue over 11 years. The 13.6% rate amounts to a compound annual growth rate (CAGR) of 1.16%. 

Exhibit: Oracle Annual Sales Revenue from Fiscal Year Ending on May 31, 2011

(Source: SEC.GOV)

How does a company show earnings per share (EPS) growth when revenue growth is nonexistent? Investors react positively to a growing EPS number. One way to show an ever-increasing EPS number is to repurchase the company shares and retire them. The repurchase transaction reduces the outstanding shares, and thus when stagnant net income is divided by outstanding shares, the resulting EPS number looks as if it is growing. 

The company has spent billions of dollars each year repurchasing its stock. The company has spent $137.65 billion in repurchasing its shares in 11 years. Initially, the share repurchases did not do much to the stock price. So, in recent years, the company has gotten even more brazen in buying back its stocks (See Exhibit: Annual Amount in Billions Spent by Oracle on Share Repurchase).  

Exhibit: Annual Amount in Billions Spent by Oracle on Share Repurchase 

(Source: SEC.GOV)

One way to analyze how much the company has spent on its repurchase is to compare its operating cash flow to the repurchase amount. The company had $155.212 billion in operating cash flow in 11 years and it spend 88.6% of that in buying back its own shares.

 

Exhibit: Oracle's Annual Operating Cash Flow

(Source: SEC.GOV)

In the end, Oracle's management led by Safra and the company's largest shareholder - Larry Ellison - benefit the most from these buybacks. Larry is now on the list of the top-10 wealthiest people in the world solely due to these buybacks. Due to these buybacks, the stock has risen a lot, and ordinary investors should prudently book profits. You do not want to be in this stock when the music stops.