the current stock market rally fundam ...
The Big Picture: What Buybacks Are Supposed to Do Stock buybacks (or share repurchases) are, theoretically, a mechanism for firms to return value to stockholders. Rather than paying a dividend, the company repurchases its own stock on the open market. There being fewer shares outstanding, each of thRead more
The Big Picture: What Buybacks Are Supposed to Do
Stock buybacks (or share repurchases) are, theoretically, a mechanism for firms to return value to stockholders. Rather than paying a dividend, the company repurchases its own stock on the open market. There being fewer shares outstanding, each of the remaining shares is a slightly larger slice of the pie. If the business is in good health and is flush with cash, this can be a clever, shareholder-friendly action. Apple, Microsoft, and Berkshire Hathaway have all done it this way — augmenting already-solid fundamentals.
But buybacks can serve a purpose as a disguise. A company that is not expanding profits may still achieve appealing earnings-per-share (EPS) growth just by contracting the denominator — the number of shares. That’s where controversy starts.
How Buybacks Can Mask Weakness
Picture a firm whose net profit is stagnant at $1 billion. If it has 1 billion outstanding shares, EPS = $1. But suppose it buys back 100 million shares, so it now has 900 million shares outstanding. With the same $1 billion in profits, EPS increases to approximately $1.11. On paper, it appears that “earnings increased” by 11%. But in fact, the underlying business hasn’t changed one bit.
This is why critics say that buybacks are a cosmetic improvement, making returns appear stronger than they actually are. It’s like applying lipstick to weary skin: it may look new in the mirror, but it doesn’t alter what’s happening beneath.
Why Companies Do It Anyway
- Executive Incentives. Executives are often paid for EPS growth or stock performance. Buybacks benefit both directly. That is an incentive to favor buybacks over investing in innovation, personnel, or long-term strength.
- Market Pressure. Investors adore “capital return stories.” When growth falters, buybacks can provide confidence and support the stock — purchasing management time.
- Low Interest Rates (in the past). Over the last ten years, low-cost borrowing facilitated it for companies to borrow cheaply and use the money to buy back shares. Some companies effectively “financial-engineered” improved EPS even when revenue or margins were flat.
- Less Growth Opportunities. Large, mature companies with fewer new market opportunities tend to turn to buybacks as the “least worst” thing to do with cash.
When Buybacks Are a Sign of Strength
It is a mistake not to lump all buybacks together. At times, they do reflect robust fundamentals:
- Strong Free Cash Flow. If a firm is producing more cash than it can profitably reinvest, it makes sense to give it back to shareholders in the form of buybacks.
- Under-valued Stock. Warren Buffett is in favor of buybacks when the shares of the company are below its value. In such a scenario, repurchases actually increase shareholder wealth.
- Balanced with Investment. When a company is financing R&D, acquisitions, and talent at the same time while still buying back shares, it indicates strong financial health.
Red Flags That Buybacks Might Be a Facade
- Debt-Financed Buybacks. When a company is using a lot of borrowed money to buy back shares while earnings plateau, that’s a red flag. It builds vulnerability, particularly if interest rates increase.
- Contraction in Investment. If capital spending or R&D is being reduced year over year, but buybacks are robust, it indicates short-term appearances are trumping long-term expansion.
- Level or Downward-Sloping Revenues. Increasing EPS with declining sales is a surefire sign that buybacks, not business expansion, are behind the narrative.
- High Payout Ratio. If close to all free cash flow is going back to shareholders, leaving little for buffers, it can be a sign of desperation.
What This Means for Investors
As an investor, the most important thing is to look under the hood:
- Verify if EPS growth is accompanied by revenue and operating income growth. If not, buybacks could be covering.
- Look at the cash flow statement — is free cash flow paying for the buybacks, or is debt?
- contrast capex trends with buyback expenditures. A firm that underinvests and over-repurchases might be in for a world of hurt in the long run.
- Hear management’s justification. Some CEOs flat out acknowledge they believe buybacks represent the most attractive allocation of capital. Others employ nebulous “returning value” malarkey in the absence of a strong argument — that’s a caution flag.
Final Human Takeaway
Buybacks are not good or bad. They’re a tool. They can truly add wealth to shareholders in the right hands — with solid fundamentals and long-term vision. But in poorer companies, they’re a smokescreen, hiding flat sales, degrading margins, or no growth strategy.
So the actual question isn’t “Are buybacks hiding weak fundamentals?” It’s “In which companies are they a disguise, and in which are they a reflection of real strength?” Astute investors don’t simply applaud every buyback headline — they look beneath the surface to understand what tale it is revealing.
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1. Why the rally does make fundamental sense There are real, concrete reasons why markets have gone up. Not everything is hype. 1. Corporate earnings have held up better than feared After massive rate hikes, most people expected: Deep profit fall Widespread layoffs Corporate bankruptcies That did noRead more
1. Why the rally does make fundamental sense
There are real, concrete reasons why markets have gone up. Not everything is hype.
1. Corporate earnings have held up better than feared
After massive rate hikes, most people expected:
Deep profit fall
Widespread layoffs
Corporate bankruptcies
That did not happen at scale.
Instead:
Large companies cut costs early
Tech firms became leaner
Banks adapted to higher rates
Pricing power remained strong in many sectors
So while growth slowed, profits did not collapse. In the stock market, that alone supports higher prices.
2. Inflation fell without destroying demand (soft-landing logic)
A big driver of the rally is this belief:
“Central banks beat inflation without killing the economy.”
That is extremely bullish for markets because:
Falling inflation = lower future interest rates
Lower rates = higher stock valuations
Consumers still spending = revenue stability
This “soft landing” narrative acts like emotional fuel for the rally.
3. Liquidity never truly disappeared
Even though rates went up:
Governments kept spending
Deficits stayed large
Central banks slowed tightening
Money never became truly “scarce.” It just became more expensive. Markets thrive on liquidity, and enough of it is still around.
4. AI investment is not imaginary
Unlike some past manias:
AI is actually transforming workflows
Cloud demand is real
Enterprise spending on automation is real
Chip demand for data centers is real
This gives genuine long-term justification to:
Semiconductors
Cloud platforms
Data infrastructure companies
So when prices rise here, it’s not pure fantasy.
2. Where it starts to look bubble-like
Now comes the uncomfortable part. Even when fundamentals exist, prices can still detach from reality.
1. Valuations in some sectors are historically extreme
In parts of the market:
Price-to-earnings multiples assume perfect future execution
Growth expectations assume:
That is not realism. That is faith.
When investors stop asking:
“What could go wrong?
and only ask:
“How much higher can this go?”
You are already inside bubble psychology.
2. Narrow leadership is a classic warning sign
Most of the rally has been driven by:
A small group of mega-cap stocks
Mostly tech and AI-linked names
This creates an illusion:
Index is strong
But the average stock is not
Historically, healthy bull markets are broad.
Late-stage or fragile rallies are narrow.
Narrow leadership = hidden fragility.
3. Retail behavior shows classic late-cycle emotions
Across platforms right now:
First-time traders entering after big rallies
Heavy options trading for fast money
Influencers calling for “once-in-a-generation” opportunities
Extreme fear of missing out (FOMO)
This is not how cautious recovery phases behave.
This is how speculative phases behave.
4. Everyone believes “this time is different”
Every bubble in history had a version of this story:
2000: “The internet changes everything”
2008: “Real estate never falls nationally”
2021: “Liquidity is permanent”
Now: “AI changes everything forever”
AI does change a lot but technology revolutions still go through valuation manias and painful corrections.
3. The psychological engine of this rally
This rally is powered less by raw economic growth and more by:
Relief (“At least things didn’t crash”)
Hope (“Rate cuts are coming”)
Greed (“I already missed the bottom”)
Narrative (“AI will change all business forever”)
Markets don’t just move on:
Earnings
GDP
Interest rates
They move on stories people emotionally believe.
Right now, the dominant story is:
That story can drive prices much higher than logic would suggest for a while.
4. So is it justified or a bubble?
The most accurate answer is this:
Fundamentally justified in:
Large parts of earnings growth
Balance sheet strength
Disinflation trends
Long-term AI investment
Bubble-driven in:
Valuation extremes in select stocks
Options and leverage behavior
Social media hype cycles
Price moves divorced from underlying cash flow growth
This is not a market-wide bubble like 2000.
It is a “pocketed bubble” environment where:
Some stocks are priced for reality
Some are priced for perfection
Some are priced for fantasy
And only time reveals which is which.
5. What usually happens in markets like this?
Historically, during phases like this, markets tend to do one of three things:
Scenario 1: Time correction (sideways grind)
Prices stop rising fast, move sideways for months, and fundamentals slowly catch up.
Scenario 2: Fast shakeout (sudden drop)
A shock event triggers:
10–25% correction
Weak hands exit
Strong companies survive
Then markets stabilize.
Scenario 3: Melt-up before crash
Greed intensifies:
Parabolic moves
Blow-off tops
Followed by a deeper, faster fall later.
The dangerous part is:
The most euphoric phase usually comes right before pain.
6. What does this mean for a real investor (not a headline reader)?
It means:
Blind optimism is dangerous
Blind pessimism is also expensive
Risk management matters more now than raw stock picking
The gap between:
This is a market that:
Rewards patience
Punishes leverage
Exposes lazy analysis
7. The honest bottom line
Here is the most truthful way to state it:
It is not a fake rally.
See lessIt is not a clean, healthy bull market either.
It is a fragile, narrative-driven rally sitting on top of genuine but uneven fundamentals.