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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