FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
February 7, 2023

IN THIS ISSUE:

1.  2022 One of Worst Years Ever For Stocks & Bonds

2. What Are Stock Buybacks/Repurchases?

3. Why Company CEOs Push Stock Repurchases

4. The Dark Side of Share Buybacks Is Very Real

5. Broader Concerns Surrounding Stock Buybacks

Overview: Do Stock Buybacks Benefit Investors?

Today, I will argue that most stock buybacks do NOT benefit individual investors, and instead mainly benefit the corporate officers and directors who make the decisions to enact these equity repurchases.

Company execs who make these decisions would like us to believe the buybacks make their investors richer but as I will discuss below, this is rarely the case.

Before we get to that discussion, however, I want to put the 2022 losses in stocks and bonds into perspective. The truth is 2022 was one of the worst years ever for stocks and bonds.

2022 One of Worst Years Ever For Stocks & Bonds

This past year was disappointing for stock and bond investors, maybe more than they even realize.

Stocks, as measured by the S&P 500, lost 18.6% which is a 25% real (inflation-adjusted) loss, placing 2022 in the bottom decile of stock returns over the past 97 years.

Bonds, as measured by the Vanguard Total Bond Index, lost 13.7%. This is -20.3% inflation adjusted, making it also in the worst decile of annual bond returns in the past 97 years.

Let’s now move on to our main topic for today: Who benefits from stock repurchases?

What Are Stock Buybacks/Repurchases?

Over the past decade, American corporations have raked in record-setting profits. On a quarterly basis, corporate gains have surged by 80%+ over the last 2 years alone, despite 40-year-high inflation and talk of a recession. For 2022, annual profits are projected to reach a new high of $12+ Trillion.

When a company is flush with cash, it can reinvest in a number of ways to grow the business, including:

• Investing in research and development
• Acquiring new equipment or technologies
• Hiring more workers
• Buying other companies

But in recent times, corporations have been spending their money on something else: Buying back their stock from the open market.

This practice is called a stock buyback, or repurchase:

STOCK BUYBACK (n): When a company pays the market value per share to buy
back a portion of its ownership that was previously distributed among investors.

For most of the 20th century, stock buybacks were largely illegal and viewed as market manipulation. But in 1982, the Reagan administration instituted a “safe harbor” rule which gave corporate executives broader permissions to use them.

Today, more than half of all S&P 500 companies engage in stock buybacks. Annual spending on buybacks has quadrupled since 2010, to $900+ Billion per year. And the 10-year total spend on buybacks now amounts to a new record high of $6.4 Trillion.

Some companies have taken the practice to an absolute extreme. Since 2012, for instance, Apple has bought back $582B worth of shares — more than the entire market cap of most Fortune 500 firms. Other top buyback spenders over the past decade include (in billions):

Microsoft: $172B                                Exxon/Mobile: $116B

Alphabet (Google): $163B                 Meta (Facebook): $116B

Proctor & Gamble: $142B                  Visa: $72B

Why Company CEOs Push Stock Repurchases

Because companies raise equity capital through the sale of common and preferred shares, it may seem counter-intuitive that a business might choose to give that money back. However, there are several reasons why it may be beneficial for a company to repurchase its shares, including reducing the cost of capital, ownership consolidation, preserving stock prices, undervaluation, and boosting its key financial ratios.

Proponents of stock repurchases make a few additional claims:

1. Buybacks Increase Value For Shareholders

Imagine a hypothetical company called ABC, Inc. that has 100 shares traded on the market. Let’s say you’re an investor and own 1 of those shares. In this scenario, you have a 1% stake in the company.

But let’s say that ABC buys back 50 of those 100 shares, taking them off the public market. Now, you own 1 of 50 shares, increasing your stake to 2%.

You still hold just 1 share, but the stock buyback has doubled your piece of the pie. On paper, that’s a good thing for you.

Of course, in the real world, most public companies have many millions of shares. So, when stock buybacks happen, the impact on investors is generally much smaller — if there’s any discernible impact at all.

In recent years, however, many companies doing stock buybacks have begun to simultaneously issue the same number of new shares as they are repurchasing, effectively keeping their total number of shares the same.

In our example of ABC, Inc. above, the company would buy back 50 shares in the public market but simultaneously issue 50 new shares, thus keeping their total number of shares the same – with no effect on shareholders.

2. They Inflate a Company’s Profitability on Paper

One of the key metrics the market uses to gauge a company’s profitability is Earnings Per Share (EPS).

The calculation for EPS is simple: NET INCOME / # OF SHARES.

The healthiest way to increase earnings per share is to make more money — create new products, increase sales and make good investments.

But many companies now use stock buybacks as a crafty way to reverse engineer EPS in their favor: Instead of increasing net income, they simply reduce the number of shares on the market.

Let’s say ABC, Inc. has a net income of $100,000 per year. Split across 100 shares, the company has an EPS of $1,000k. If ABC Inc. buys 50 shares and makes them “disappear,” the EPS increases to $2,000 – assuming they don’t issue any additional shares.

On paper, this one stock buyback has doubled the company’s EPS without improving the business in any meaningful way.

But the true impact of share buybacks has been called into question by a growing number of analysts.

A 2016 analysis by McKinsey concluded that buybacks are “generally a wash” – and while they can boost earnings in the short-term – they don’t actually create lasting value for shareholders.

The Dark Side of Share Buybacks Is Very Real

Critics have suggested that buybacks are motivated mainly by the greed of executives who stand to benefit from them.

More than 30% of all executive compensation plans are tied to EPS. Managers may take money from other areas of the company and carry out buybacks for personal gain even if the timing isn’t right.

This greed comes with consequences — for long-term success, workers and the market.

In theory, companies should only do buybacks when:

• They don’t have anything better to do with their cash on hand.
• Prices are low and they can get a better deal on the shares they buy.

But recently, more and more companies have broken those rules.

Look no further than the plight of the US airlines industry.

Between 2014 and 2019, the four major airline carriers collectively spent 96% of their cash flow ($39.1B) on stock buybacks.

Then when the Covid pandemic hit in 2020, the industry tanked.

But because the airlines blew their rainy-day fund on buybacks, they had to rely on a $54B bailout from the US government to maintain payroll for 18 months. That bailout was funded by taxpayers, and the airlines will only have to pay back $14B of it.

Meta (Facebook) is another cautionary tale. From July 2021 to June 2022, the company bought $48B worth of its own shares at an average cost of $303/share. Recently, Meta’s stock price fell below $140. On paper, the buybacks were a $26.2B loss (-55%).

Recently, Meta announced it would lay off 11k employees to save money.

Broader Concerns Surrounding Stock Buybacks

Economists have sounded alarm bells over soaring corporate debt in recent years — and many say that buybacks are one of the root causes.

Nearly half of all buybacks in the past few years have been financed with loans. Companies have gone beyond their own cash reserves and have taken on huge amounts of debt to buy back shares.

This has come at the expense of real, long-term business investments and expansions.

A counterargument to all of this is that buybacks can help boost share prices, helping everyday investors make money.

But ultimately, buybacks disproportionately benefit the wealthiest Americans: 84% of the stock market is owned by the top 10% of US households. Just under 7% is owned by the bottom 80%.

There are some efforts to tame the practice: Under the recently passed Inflation Reduction Act, a 1% excise tax will be levied on the fair market value of stock buybacks carried out by publicly traded firms.

Yet it’s not doing much to quell corporate America. In the first few weeks of 2023, several companies have already announced $3 Billion in buybacks — more than this time last year.

The bottom line: While some corporate share repurchases increase value for shareholders, many corporate share buybacks only benefit company executives and not individual shareholders. Now you know the difference.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Are Corporate Share Repurchases A Good Thing Or Bad Thing? It Depends

What Are Stock Buybacks & Why Do Companies Use Them

Gary's Between the Lines column:
Politicians No Longer Reflect The Values Of Their Voters

 

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