For the first time, stock buybacks by companies in the S&P 500 are on track to surpass $1 trillion in a calendar year. Authorizations for buybacks had already reached $220 billion by mid-February, which firmly set the pace for this new record.1
The surge in stock buybacks marks a sharp contrast from corporate activity in the fourth quarter of 2022. Based on Q4 earnings reports from about 90% of S&P 500 companies, companies were largely using their cash to boost dividend payments to shareholders and to increase capital expenditures. Dividend payouts rose by 9% in Q4 while investment (capex) jumped by 18% year-over-year.
There are two observations I’d like to point out from this Q4 data. The first is that U.S. corporations are still flush with cash, as evident from the chart below showing total cash on hand and in banks:
The second observation is that companies appear to be largely unfazed by the new 1% federal tax on net stock buybacks, which took effect on January 1. We were watching closely to see if U.S. corporations would rush to pull forward share buybacks late last year in an effort to avoid the tax, but that didn’t happen. Interestingly, share buybacks fell by -18% in Q4 from the year before, but then surged in Q1 2023 once the tax had taken effect. There may be a few ways to interpret this behavior, but the bottom line is that the new tax doesn’t appear to be having an impact on corporate decision-making – a good sign, in my view.
There are three key reasons companies will opt to buy back shares, and investors should consider these when they encounter companies authorizing buyback programs (which many major U.S. companies are).
- Demonstrate confidence in the business.
When a company buys back their shares, it is often a move by management to demonstrate they are still confident in the business and its forward-looking prospects. Buying back shares when there is a significant amount of economic uncertainty and weak investor sentiment – as we’re arguably seeing now – is a way to signal strength and optimism to shareholders.
- Return capital to shareholders.
More so than any time dating back to 2017, shareholders want companies to return capital – either through buybacks or dividends. A company’s decision to authorize a share repurchase plan is in many cases a response to what shareholders are asking for.
A key feature of stock buybacks is that they do not accrue additional taxes for shareholders, unlike dividend payments which are taxed as income. In this sense, buybacks are a way to return capital to shareholders without triggering a taxable event. Companies also sometimes like using buybacks versus dividends because they can more easily adjust buyback amounts/schedules as market and economic conditions change, unlike dividends and capex which is less flexible once initiated.
- Improve earnings-per-share and potentially boost the share price.
Finally, when companies buy back their own shares, they are essentially reducing total share count – which can mean giving an instantaneous boost to earnings per share. Think about it this way: if earnings stay the same but the number of shares decreases, then EPS goes up without the company having to generate any additional net income. In Q4, less than 70% of S&P 500 companies exceeded earnings expectations, which is a low beat rate relative to history. Share buybacks can improve the EPS picture.
Buybacks can also boost a company’s share price. Since stock prices are determined by supply and demand – and share buybacks are a method for reducing supply – they inherently put upward pressure on prices. It doesn’t always work out that way, since demand is constantly changing as well, but it does provide support.
Bottom Line for Investors
Share buybacks are not always a positive or bullish sign for a company. In some cases, share buybacks can signal a company is getting desperate to prop up their stock price, which investors should heed as a warning signal. Using cash for buybacks also means having less cash available to fund operations, new investments, hiring, and so on, which can resurface as a risk later on. Investors should look at a company’s buyback plans on a case-by-case basis.
One of the largest criticisms of share buybacks is that companies should be using their extra cash to invest in new jobs and new growth, not on repurchasing shares just to potentially boost the share price and prop up EPS numbers. It’s a fair debate to have, but in my view, it does not necessarily hold water when companies are repurchasing shares and spending solid amounts on new investments. As seen in the chart below, private nonresidential fixed investment (capex) is still running at strong levels, even as buybacks gain momentum.
Disclosure
2 Fred Economic Data. December 22, 2022. https://fred.stlouisfed.org/series/QFRTCASHINFUSNO#
3 Fred Economic Data. February 23, 2023. https://fred.stlouisfed.org/series/PNFI#0
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