Mitch's Mailbox

December 18th, 2020

What Investors Should Know About Stock Buybacks

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Jerry C. from Murfreesboro, TN asks: Seasons Greetings, Mitch. I’ve read a few articles recently about stock buybacks, which to date I have seen as a good thing for stock owners. Seems like a new administration may try to pull the reins on the practice. What are your thoughts here? Would changing buyback rules hurt stock prices?

Mitch’s Response:

That’s a great under-the-radar question, Jerry, and one that I do think could have some impact going forward.

For readers who may be unfamiliar with stock buybacks or share repurchases, it’s when a corporation uses capital to buy its own shares, thereby reducing share count and effectively boosting shareholder equity value at once. Companies can use their cash in a variety of ways: research and development, investing in a new plant or product, pay increases, new hiring, dividends, or share repurchases – just to name a handful.

Stock buybacks have been around since 1982, when they were legalized by the Reagan administration. But they really took off in the early 90’s, when a 1992 tax bill capped corporate tax deductions for executive pay over $1 million. Corporations increasingly shifted to stocks and options to increase executive pay, and today’s buybacks are often used to offset some of the new stock issues paid to CEOs and the like.1

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The fresh scrutiny being given to stock buybacks is a result of the most recent Tax Cuts and Jobs Act of 2017, when corporations were given a tax break to repatriate billions of overseas profits. The thinking was that the repatriated money would be deployed to investment, pay increases, and surging economic growth. A lot of capital was indeed used for investment, but stock buybacks also soared. Companies repurchases of their shares jumped 55%, to a record $806 billion. Much of the new positive cash flow from the tax break was shifted to shareholders. As an equity investor, this is generally good news.

In regards to your question, I do think there is quite a bit of interest in adjusting stock buyback practices. But the range of proposals to date is all over the map, and trying to game the outcome from where we sit today is virtually impossible. While I do think share repurchases boost shareholder equity and are generally good for stock prices – which is our concern here at Zacks Investment Management – I am not fully convinced that reining them in will be a net negative for stocks.

That being said, I think a big piece of investor due diligence is to closely scrutinize how and why companies are using stock buybacks. In some cases, a company may be repurchasing shares to make up for lack of innovation and new growth. In a sense, it’s an ‘artificial’ way to boost shareholder value. I’ve also seen companies taking advantage of the low interest rate environment to take on more debt for the express purpose of buying back stock. Investors should raise an eyebrow to this practice.

A recent MSCI study found that as buybacks have soared over the past 30 years or so, dividends have held relatively steady but capital spending has fallen by nearly 50% and spending for research and development is also down considerably. That’s not a great trend in aggregate, and investors should take this into consideration when making decisions. Companies that are innovating, investing in new plants and products, hiring more workers, and spending in an effort to grow and lead may have a stronger future than companies borrowing and using capital simply to buy back stock.

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Disclosure

1 Wall Street Journal. December 5, 2020. https://www.wsj.com/articles/stock-buybacks-what-every-investor-needs-to-know-11607185864?mod=djemMoneyBeat_us

2 ZIM may amend or rescind the “Dean’s List of Investment Strategies” guide for any reason and at ZIM’s discretion.

3 ZIM may amend or rescind the “Dean’s List of Investment Strategies” guide for any reason and at ZIM’s discretion.

4 These rankings may not be representative of any one client’s experience. In addition, they are not indicative of future performance

DISCLOSURE

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by other parties. Zacks Investment Management does not assume any responsibility for the accuracy or completeness of such information. Further, no third party has assumed responsibility for independently verifying the information contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are based upon opinions or assumptions that Zacks Investment Management considers to be reasonable.

Any investment inherently involves a high degree of risk, beyond any specific risks discussed herein.

Returns for each strategy and the corresponding Morningstar Universe reflect the annualized returns for the periods indicated. The Morningstar Universes used for comparative analysis are constructed by Morningstar (median performance) and data is provided to Zacks by Zephyr Style Advisor. The percentile ranking for each Zacks Strategy is based on the gross comparison for Zacks Strategies vs. the indicated universe rounded up to the nearest whole percentile. Other managers included in universe by Morningstar may exhibit style drift when compared to Zacks Investment Management portfolio. Neither Zacks Investment Management nor Zacks Investment Research has any affiliation with Morningstar. Neither Zacks Investment Management nor Zacks Investment Research had any influence of the process Morningstar used to determine this ranking.
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