during the 12 months ending June 30; S&P 500 companies spent a record $1 trillion to buy back their own stock, according to S&P Dow Jones Indices. But a new 1% tax on buybacks in January could dampen corporate America’s appetite. S&P Dow Jones estimates the tax would reduce corporate profits by half a percentage point at current buyback rates.
Buybacks have recently become controversial, with critics arguing that there are better uses for corporate cash. But a 2020 S&P Dow Jones Indices analysis of the 100 largest buyback companies found that their long-term stock returns generally outperformed the S&P 500.
Many smart investors, including Warren Buffett, are big proponents of strategic buybacks. “If management wants to further strengthen our ownership through share buybacks, we welcome it,” he said.
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The new tax is low enough to discourage only the most minimal buybacks, experts say, so don’t expect them to go away. But buybacks can be tricky to estimate. For investors trying to navigate this changing market, a few signals can help you find stocks that could benefit from share buybacks despite the tax. But first, the basics.
The parties. A buyback makes a lot of sense when a company can sweep up shares whose prices have irrationally fallen below their fair value due to market fluctuations. Such purchases signal insiders’ faith in the company and increase demand, which drives the share price.
Many investors prefer buybacks to dividends because although you have to pay taxes on dividends when they are issued, you don’t pay capital gains taxes until you sell your shares. Also, when companies buy back more shares than they issue, each remaining share represents a larger portion of the company’s ownership.
Some investors want companies to distribute cash through buybacks so managers aren’t tempted to make worse choices, said Meb Faber, chief investment officer at Cambria Investment Management. “How many companies have wasted money on naming stadiums?”
Executives like buybacks because by reducing the number of shares outstanding, a company can report higher earnings per share even when total earnings are flat or lower. That can be a particularly tempting strategy for any executive whose compensation is tied to growth in earnings per share.
Buybacks also give managers flexibility. A company that raises its dividend risks a stock collapse if later difficulties force it to cut payouts. A buyback program, however, can usually be suspended without disturbing investors. Another advantage. each share brought home means paying one less dividend for companies that also pay dividends, reducing future cash liabilities.
After all, economists love buybacks because they take cash from companies that don’t have good internal investment ideas and return it to shareholders, who then reinvest it in other public companies (which presumably have better investment plans).
| year | Share Buybacks (Billions) | Dividends (billions) |
|---|---|---|
| 2022 (until June 30) | 501 dollars | 278 dollars |
| 2021 | 882 | 511 |
| 2020 | 520 | 483 |
| 2019 | 729 | 485 |
| 2018 | 806 | 456 |
Against Sens. Elizabeth Warren (D-Mass.) and Marco Rubio (R-Fla.) Sens. Elizabeth Warren (D-Mass.) and Marco Rubio (R-Fla.) have tried to discourage buybacks. Critics hope to force companies to invest more in their operations, creating new jobs.
While some studies highlight the positive aspects of buybacks, others conclude that shareholders often benefit more from alternative uses of cash. Greg Milano, CEO of investment advisory firm Fortuna Advisors, said Fortuna found over the past 12 years that, on average, companies that increased earnings per share due to investments in operations had twice the share price gains as companies that raised one share. share profits through buybacks. Dividend payments also resulted in slightly higher returns than buybacks.
And Milano cautions that despite the hype, many buybacks don’t end up giving investors a bigger stake in the company, because companies often issue more shares in stock-based compensation plans than they buy back. Worse, investors have been burned by companies that have spent billions on buybacks instead of cleaning up their balance sheets or investing in their businesses to hedge against downturns, as some airlines have done recently. (see more about airlines Why are airline stocks a bad deal?)
How to cash out? Experts say investors who still want to take advantage of buyback programs should follow three principles: The stocks listed below provide good examples.
Avoid dilution. Don’t jump at every purchase announcement. Check to see if the company’s total number of shares is actually going down, thereby increasing your ownership stake in the company, Faber advises. You can look up a company’s outstanding shares in its securities and stock exchange filings, or you can find its share count on sites like Yahoo Finance and YCharts. It’s a good example McKesson (MCK: (opens in new tab)), says Faber, whose investment firm owns the stock. The drug and medical supplies distributor has shed 7% of its stock in the past year, and its stock price has doubled over the past five years.
Look for price discipline. Successful repurchasers, like successful investors, must buy low. Buffett Berkshire Hathaway (BRK.B: (opens in new tab)), with more than $100 billion in cash, buys back its own stock when the price falls below what Buffett calls its “intrinsic value.” Morningstar sector strategist Gregory Warren notes that the company has bought back $58 billion worth of its common stock since 2019, reducing its share count by about 10%. Berkshire bull Warren believes the company is focused on reducing its long-term cash hoard through a mix of share buybacks and share buybacks.
Bet on healthy companies. Fortuna’s Milano said companies that are likely to have high long-term returns from their buybacks have strong balance sheets and, ideally, are less vulnerable than other companies to economic or commodity cycles. One company is high on his list. Apple: (AAPL: (opens in new tab)) since the start of 2021, Apple has bought back more than $200 billion of its own stock, reducing its share count by about 5%. During that time, the stock has gained roughly 6%, excluding dividends, compared with a 3% loss for the S&P 500 index. S&P Dow Jones Indices senior analyst Howard Silverblatt says: “Apple is the indicator of buybacks.”
