Some Perspective on Buybacks Given Recent Criticism

Buybacks have been put back into the spotlight as boogeymen. Earlier this week, Senators Chuck Schumer and Bernie Sanders wrote an op-ed in The New York Times attacking share repurchases. Among their accusations were that stock buybacks mostly benefit the wealthy and divert money from being spent on capital expenditures, salary increases and other worker benefits.

It’s not the first time buybacks have been criticized and I doubt it will be the last. Making buybacks a scapegoat is an easy sound bite to score political points with. The reality about share repurchases is more complicated; as such, I’m going to provide some perspective.

If you invest in stocks, you should prefer companies with either falling counts of shares outstanding or at least no increase in the number of shares outstanding, all other things being equal. Such stocks have outperformed by a big margin, with annualized gains of 17.5% and 16.6% based on data from Dartmouth professor Kenneth French’s data library for the period of 1964 through 2018. You also want to avoid the companies with the largest increases in share counts; such companies have annualized returns of just 4.4%.

If you invest in stocks, you have some wealth. At least enough wealth to set aside money for a period of time before it needs to be spent. While the affluent own more stocks, anyone who invests in the stock market benefits when share prices rise. Thus, attacking buybacks because it makes the affluent wealthier is misplaced criticism. Yes, the person with a $2 million or $20 million portfolio realizes a greater increase in wealth, but those with equity exposure of $2,000 or $20,000 also benefit when buybacks boost share prices.

The benefit from stock repurchases is indirect. A direct benefit would be receiving cash because you sold your shares to the company conducting the repurchase program. When buybacks occur on the open market, the odds of you or me directly selling to the company are very slim. The most likely occurrence is us selling our shares to another investor. What does happen is that our ownership interest increases relative to the reduction in the number of shares outstanding. Put differently, our slice of the ownership pie gets a little bigger. Additionally, since there are fewer shares outstanding, the laws of supply and demand work in our favor.

Share repurchases do require an outflow of cash from corporations. Critics of buybacks argue such dollars should be spent elsewhere. Data from S&P Dow Jones Indices shows S&P 500 index companies spending a record $203.76 billion in the third quarter of 2018 versus a six-year average of $140.88 billion. Dollars spent on buybacks soared following the passage of the Tax Cuts and Jobs Act due to the combination of tax savings and repatriation. S&P 500 companies also spent $18.59 per share on capital expenditures (capex) during the third quarter. This compares to six-year average capex of $16.87 per share. On a rolling four-quarter basis, capital expenditures per share are also at a six-year high. So, S&P 500 companies are reinvesting in themselves in addition to buying back stock.

While many cheer capital spending for its economic benefit, too much capex isn’t a good thing. French’s data shows companies with the lowest proportionate year-over-year growth realizing an annualized return of 16.8% over the past 55 years. Stocks of companies with the highest growth in assets mustered just a 6.5% annualized return.

None of this addresses the issue of wage growth. No CEO is going to say on a conference call that they need to cap salaries to keep buying back stock or raise the dividend. This doesn’t mean the cause of disappointing wage growth is buybacks (or growing dividends). The reality is more complex, as there are several other factors at play (e.g., expected business conditions, the stickiness of wages, pressures to maintain margins, structural issues, etc.). Just as the new tax bill has not led to the stronger pace of wage growth its proponents claimed it would, neither should the proposed legislation on buybacks be expected to necessarily do so.