The buyback season is open once again.
President Biden blasted large oil corporations in his State of the Union speech earlier this month for using record profits "to buy back their own stock, rewarding their CEOs and stockholders." He then suggested quadrupling the current 1% federal tax on buybacks.
It's not unexpected that he disliked buybacks. According to S&P Dow Jones Indices, major American corporations have spent $3.9 trillion buying back their own stock during the last five years.
Thus, as critics have claimed for years, are corporate top executives starving their companies to fatten themselves and their shareholders? Or do buybacks serve as a type of magic bullet that enables investors to put their money to the best possible use?
Buybacks are neutral in nature. They serve only as a tool. Buybacks are helpful in the right corporate hands and hazardous in the wrong ones, just like you can use a hammer to build or destroy a house.
In a buyback, a business spends funds to buy back some of its shares from shareholders who want to sell them, usually at market value. Investors who take part receive more cash and a lesser share of the company; the company ends up with less cash and fewer shares outstanding.
It is simple to come up with instances of failed buybacks.
In 2007, Lehman Brothers Holdings Inc. spent $2.6 billion repurchasing its own stock; in the first two fiscal quarters of 2008, it spent an additional almost $1.5 billion. The Wall Street titan went bankrupt less than six months after that.
From 2004 through 2008, Citigroup Inc. repurchased more than $20 billion in shares—just before it required a roughly $45 billion government bailout during the financial crisis, as Trade Algo snidely noted in 2009.
According to Bed Bath & Beyond Inc.'s most recent quarterly report, the struggling retailer has bought back 265 million shares since December 2004 for a total of $11.7 billion. Some of those shares cost more than $26 during the 2021 meme-stock fad. The stock was down this week.
Don't let a few isolated anecdotes prevent you from seeing the overall body of data. The validity of some of the rhetoric surrounding buybacks can be determined by taking a critical look at it.
Companies are deprived of funds through buybacks that they may more profitably use for commercial expansion.
The implication of this criticism is that the same management we shouldn't trust to use surplus cash appropriately in a buyback will do it appropriately for other purposes.
But expecting a typical CEO to hold onto heaps of extra money is like expecting a lion to not eat a lot of raw meat when you put it in front of him.
My favorite examples are from the 1970s, when large oil firms had significantly more capital than they could invest in new wells, just as they do today.
Exxon Corp. spent $1.2 billion purchasing an electric motor manufacturer in 1979 instead of repurchasing shares, only to sell it off a few years later while barely breaking even. Exxon also invested at least $1 billion in cutting-edge office furnishings, only to abandon those ventures by the middle of the 1980s.
Mobil Oil Corp., Exxon's then-rival, paid more than $1 billion to acquire a business that produced cardboard boxes and managed the Montgomery Ward department store chain. That also failed.
Companies have been artificially hyping their market value by repurchasing their own shares.
Professors of accounting and finance Nicholas Guest of Cornell University, S.P. Kothari of MIT, and Parth Venkat of the University of Alabama recently published a study titled "Share Repurchases on Trial" that examines the stock returns of thousands of companies from 1988 to 2020, contrasting those that repurchased shares with those that did not while controlling for factors such as size. Companies that conducted significant or frequent buybacks had marginally lower—not higher—returns in the year of the repurchase. Their returns were identical when viewed over larger time frames.
Similar findings from 1967 research were reported.
Businesses that engage in buybacks make lower capital or R&D expenditures.
Newer businesses with excellent internal growth potential frequently invest all of their cash back into the company, leaving little for buybacks. Share repurchases are a suitable use for the surplus as companies mature, their growth opportunities diminish, and their business generates more cash than they require.
As a result, decelerating companies typically engage in buybacks while accelerating companies do not. The short-term market performance of slower-growing companies that engage in buybacks ends up being slightly worse because investors often pay more for fast-growing stocks.
Companies don't generally invest less because they are conducting buybacks. Because they don't have as much money left to invest, they do buybacks.
Because overpaid CEOs are utilizing buybacks to boost their own remuneration, they are on the rise.
While the monetary amounts of buybacks have increased, they have decreased nearly in half since 2007 as a percentage of the entire value of the U.S. stock market, from 1.3% to about 0.7%, according to S&P Dow Jones Indices. The increase in stocks as a whole has been much larger than the repurchase boom.
Source: S&P Dow Jones IndicesS&P 500 quarterly buybacks as a percentage of market valueNote: 3Q 2022 number is provisional.
Furthermore, according to the "Share Repurchases on Trial" study, CEOs of businesses that buy back shares do not receive considerably higher remuneration than CEOs of similar companies that don't buy back shares. This includes salary, bonuses, and stock options. CEOs that engage in buybacks typically earn just 1% extra overall.
According to research co-author S.P., "We don't notice huge usage as some people allege." MIT's Kothari "CEOs aren't stuffing their pockets with money in this rigged game,"
Investors who participate in buybacks are given a free choice between returning their shares to the company or keeping them. Although they won't make you wealthy, they could help keep CEOs from making you impoverished. Stop demonizing them, politicians on both sides of the aisle.
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