The Stock Buyback Binge
A rising stock price used to mean a company was doing something right, said Alain Sherter in CBSNews.com: releasing great products, conducting trailblazing research, even benefiting from visionary leadership. Today, though, the company might just be “buying a boatload of its own shares.” Stock buybacks, which help juice a company’s short-term stock price by reducing the number of outstanding shares, are nearing historic levels. U.S. companies spent $516.7 bil lion buying their own shares in the first nine months of this year, the highest amount since the record first three-quarters of 2007. Firms love buybacks because they can effectively boost earnings per share, since there are fewer shares in circulation, even if a company’s total earnings fall or stay flat. In fact, since 2009, buybacks have been responsible for 21 per cent of the overall increase in market value for S&P 500 firms.
“What’s not to like about companies purchasing their own shares from time to time on the open market?” asked Russ Wiles in the Phoenix Arizona Republic. Investors tend to cheer buybacks, because their portfolios benefit and there are certain tax benefits over regular dividends. And unlike dividends, companies see buybacks as a one-off way to reward shareholders without setting the expectation that they’ll continue in the future. The downside? Money that’s spent on buybacks is money that’s not being spent to grow the business. In fact, “showering cash on shareholders may exact a long-term toll” on a company’s health, said Karen Brettell, David Gaffen, and David Rohde in Reuters.com. Consider Hewlett-Packard. The onetime poster child for innovation began billions of dollars in stock buybacks when Carly Fiorina took the reins in 1999.
By the time Fiorina was ousted in 2005, the company had purchased $14 billion of its stock, more than its $12 billion in profits during that time. Her successors continued the mega-buyback trend, even as the core business deteriorated steadily. And HP is hardly alone. Among the 1,900 companies that have repurchased their shares since 2010, money devoted to buybacks and dividends amounted to 113 percent of their capital spending, compared with 38 percent in 1990.
Buyback defenders would tell you to follow where the money ultimately goes, said Justin Fox in BloombergView.com. Part of the rationale for buybacks is that investors take their earnings and reinvest them in new, promising ventures. But a closer look at the data suggests that isn’t happening. Total shareholder payouts were more than $1.2 trillion in 2014, but investors reinvested less than $200 billion in the form of IPOs and venture capital. Want to know why executives love buybacks so much? asked Barry Ritholtz, also in BloombergView.com. “Because so much of the proceeds of buybacks end up in their own pockets.” Even as companies buy back stock in record amounts, they’re also issuing new shares that go directly into executive pay packages. All the while, they’re letting their business suffer for lack of investment. Investors really should ask themselves: “Why is management at so many companies bereft of better ideas and more productive uses for corporate cash?”
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