Europe’s supply of public equity is shrinking at fastest rate in history

Large-cap companies across Europe and the UK are buying back shares at unprecedented rates, new research from Goldman Sachs reveals.

This is leading to a situation where high buyback-yielding stocks are outperforming high dividend-yielding stocks.

Public equity shrinks

Goldman expects the STOXX 600 index (comprising Europe and the UK’s largest listed companies) to return half a trillion euros (£431.4 billion/US$533 billion) to shareholders between now and the end of 2025.

This suggests a 5% yield generated from buybacks and dividends, with banks and energy firms expected to deliver half of these returns.

“In Europe, dividends will remain the main source of return but buybacks are growing and can provide more flexibility,” wrote researchers led by Guillaume Jaisson. “Indeed, the main buyers of equity in recent years have been corporates, via share buybacks.

“Even corporate insiders, executives and officers are buying more shares in their own firms than they are selling.

“The combination of buybacks and a lack of new issuances has meant that the net supply of public equity is shrinking at its fastest pace in history.”

Over the past 12 months, the universe of European public equities, including UK stocks, already shrank by €170 billion, which is equivalent to 1.5% of the STOXX 600’s total market capitalisation.

What is causing this groundswell in capital reduction?

Show me the money

An excess of cash, is the simple answer.

Goldman’s research shows that STOXX 600 companies are sitting on nearly €1.5 trillion of cash on their balance sheets.

This is 35% up compared to pre-Covid levels, while the cash-to-asset ratio is currently higher than the 2005 level, “which preceded a major boom in capex, M&A and buybacks”.

Telecoms firms, automotive manufacturers, commodity producers and financial services companies are the primary holders of this spare change.

Autos and telcos do, however, face mounting capital expenditure pressure on the horizon to keep pace with industry transformations, making commodities producers and financial institutions the favoured picks for income-seeking investors.

With a 5% yield (comprising 3.5% in divis and 1.5% in buybacks), European stocks appear to be a decent alternative to German bunds and US Treasuries, and will likely be more attractive when rates begin to come down.

Since Europe has “rarely looked cheaper on an absolute and relative basis”, the STOXX 600 could also be a decent alternative to the highly-priced S&P 500 in the US.

“The yield differential with the S&P 500 is the widest ever which makes European equities a reasonable alternative to the US,” said Goldman researchers.

Choose buybacks over divis, Goldman suggests

Of course, there is no free lunch in the world of investing and Goldman highlighted a trade-off between value and growth.

The research points out that while high buyback yield stocks have outperformed those with low buyback yields, high dividend yield stocks have underperformed compared to their low dividend yield counterparts.

“In this environment, we continue to recommend a long on our buyback basket (GSSTREPO),” said Goldman.

UK-listed companies included in this basket are Compass Group, Burberry Group, Shell PLC (LSE:SHEL, NYSE:SHEL), BP plc, The London Stock Exchange Group PLC (LSE:LSEG), Diageo PLC (LSE:DGE) and Imperial Brands PLC (LSE:IMB).

As for Goldman’s dividend basket (GSSTDIVY), UK-listed groups include Rio Tinto plc, Berkeley Group Holdings, British American Tobacco PLC (LSE:BATS), Coca-Cola HBC and AstraZeneca PLC (LSE:AZN).