Why Now-Reviled Stock Buybacks Will Rise Anew

The once-popular repurchases look wasteful today, but once the economy improves, their appeal may well spring back.

Reported by Larry Light
Art by Andrea D'Aquino

Art by Andrea D’Aquino


Buybacks, long a share price-boosting Wall Street darling, have suddenly become pariahs. As the coronavirus rages across the world, as businesses shut down and unemployment surges, stock buybacks now seem like gratuitous gifts for well-off investors at best and irresponsible misuses of scarce capital at worst.

This sea change has resulted in a vast retrenchment of companies repurchasing their equity from shareholders. Yet once the crisis passes and the economy rights itself—which may take some time—don’t be surprised to see buybacks re-emerge. Why? They are popular with managements and investors for a reason, so a restoration of prosperity and a fading of their current taint should restore them to grace.

“They’ll come back, but quieter and slower,” said Randy Hare, director of research for Huntington Private Bank. “They’re a great use of capital. Right now, of course, if you do a buyback, you’re one tweet away from getting slammed,” he added, referring to the animosity toward them from President Donald Trump and other politicians.

The rough road the market has traveled since late February needs to smooth out considerably, however, for buybacks to stage any comeback. “We need relative normalcy,” said Don Townswick, Conning’s director of equity strategies, for them to possibly return. “They’re off the table for the foreseeable future.”

Part of the retreat from buybacks is that, aside from the tech giants and some other deep-pocketed megaliths, many companies are seeking to conserve resources against the unknown—where an economic recovery may be many months away, or longer. “This is the time to practice risk management and conserve cash,” said Bill Booth, co-CIO of Epoch Investment Partners.

While the pros and cons of buybacks are endlessly debated, the practice has established itself as a retro-rocket for sending stock prices soaring. Since 2009, buybacks have added a net $4 trillion, or about 23%, to the S&P 500’s market value, which now is almost $21 trillion, by the reckoning of research firm Reynolds Strategy Group.

What about the contribution of other market investments, such as from mutual funds, pension programs, and individuals? The firm’s analysis of Federal Reserve fund flows finds they have netted out to zero because their providers also withdraw a lot of money from the market, too.

Why Companies Will Love Buybacks Again

In and of itself, the buyback movement does nothing to enhance a company’s profitability, although some metrics make out repurchasing as a financial winner. On paper, earnings per share (EPS) do grow since there are fewer shares to divide into net income (minus preferred dividends), which yields a fatter EPS. What’s more, evidence does exist that buybacks often push the affected stock price upward. All of that is a good thing for corporate executives, whose pay often is linked to rising EPS and share values.

More tangibly, buybacks are helpful at increasing incomes of company employees with stock options, not just the top brass. Further, they encourage prudent cash management to ensure that vital operations go forward after the repurchases, argued Nancy Prial, co-CEO of Essex Investment Management. Plus, she added, they can ease future company capital raises via fresh stock offerings sold to buyback-enthused investors. “Buybacks do serve a good corporate purpose,” she noted.

Companies like the flexibility of buybacks, which can be adjusted readily. Dividends, another means to awarding corporate cash to shareholders, carry an implicit promise that they will be regular and increase over time. Reducing or axing dividends tends to keelhaul a stock. 

On more macro terms, the brief for buybacks holds that they are recirculating cash from more seasoned businesses, which have little need for it, to rapidly growing upstarts that can put it to more productive use.

Consider Apple, the hands-down buyback champ, and the second most highly valued company on earth (after Microsoft). Since it began its repurchasing campaign in 2013, the iPhone maker has shelled out $400 billion to stockholders. At the same time, it has been solidly profitable and at last tally had $207 billion cash on its balance sheet, more than half of its buyback outlay.

Meanwhile, Apple hasn’t stinted on capital spending, disbursing $14 billion last year on new manufacturing capacity and data centers to support its booming service activities. In other words, the company has ample resources to expand and also reward investors.

OK, so perhaps shareholders who scored a bonanza from Apple by selling it their stock might turn around and plug the money into, say, a biotech working on a virus vaccine. Or the Apple windfall could go into a new app that makes shopping easier for shut-ins. Or into a celebrated tech tyro such as Zoom Video Communications.

The videoconferencing company, which went public last year, is a virus-sheltering hit, with hordes of home-bound people using it for everything from Zumba classes to staff meetings. In its fiscal year ending in January, Zoom reported its revenues have doubled, and its earnings have more than tripled. In spite of some embarrassing security breaches, the stock this year is up 88%, while the S&P 500 has tumbled.

That said, buybacks have their own paradoxical rhythms, which basically revolve around giving investors (to include company employees) a gift. They do the opposite of buy low and sell high. The frothier the stock market, the more eager managements are to pay top dollar to reduce share count. That’s not the situation these days, for sure.

Stock Buybacks Retreat, Often Amid Troubling Signs

Total value of share repurchases for S&P 500, in billions

$1,000

Tax cut takes effect

$800

$600

Mid-decade oil bust

$400

European debt crisis

$200

2011

2013

2014

2015

2016

2017

2018

2019

2012

Total value of share repurchases for S&P 500, in billions

$1,000

Tax cut takes effect

$800

$600

Mid-decade oil bust

$400

European debt crisis

$200

2013

2014

2015

2016

2017

2018

2019

2011

2012

Total value of share repurchases for S&P 500, in billions

$1,000

$800

$600

$400

$200

2011

2013

2014

2015

2016

2017

2018

2019

2012

2012

European debt crisis

2016

Mid-decade oil bust

Tax cut takes effect

2018

Total value of share repurchases for S&P 500, in billions

$1,000

$800

$600

$400

$200

2014

2016

2018

2012

2012

European debt crisis

2016

Mid-decade oil bust

Tax cut takes effect

2018

Source: S&P Dow Jones Indices

 

Take a look at the S&P 500’s trajectory over the past decade. While the bull run was remarkable, lasting 11 years until it expired in February, the only times the rally flagged were when economic problems appeared. To wit, the European debt crisis in 2012 and the first oil-price bust in 2015-16.

Today, with the world free-falling into a recession, companies are yanking their buyback plans with a vengeance. Even though right now presents a great opportunity to gather in shares on the cheap, managements have balked.

From Hero to Heel

The good old days for buybacks lasted until a little more than a month ago. The 2017 tax cuts super-charged repurchases in 2018, when the reductions took effect: Buybacks hit a record $806 billion then. Last year, they ebbed a bit, to finish at $728 billion bought in, still a whopping amount. Reasons for the fall-off: The waning power of the tax cuts, a small shrinkage expected in corporate earnings, and signs of slowing economies worldwide.

Cue the high-water mark for pulling in shares. In early March, Hilton Worldwide announced an extra $2 billion in buybacks, a nice add-on to a program that had ponied up $1.5 billion for shares in 2019. Hilton stock rallied 5.5% on the news. Then the world turned upside down, as travelers canceled bookings. Reeling from this thunderbolt, the lodging chain scrapped its buyback plans.

The changed economic climate and hence the political situation are the major drivers in making buybacks, for the time being, radioactive. Thus far, 48 companies in the S&P 500 have suspended their programs. They range from JPMorgan Chase to Chevron, from AT&T to Carnival, from McDonald’s to Nordstrom. Among companies apparently unwilling to scrub buying in shares, the most prominent are tech titans such as Apple.

“Buyback activity will slow dramatically, both for political and practical reasons,” a recent Goldman Sachs research note stated. “First, politicians are denouncing repurchases given the impending recession. Second, from a practical perspective, as revenues evaporate, firms will be looking to preserve cash.”

S&P Dow Jones Indices predict buybacks will plummet to as low as $120 billion in 2020. And even that sounds too high to some Wall Street strategists. When Congress rammed through a $2.2 trillion rescue package in March, the law stipulated that no company taking aid is permitted to do buybacks. This was a rare instance when lawmakers from both parties and the president united in condemning share repurchases.

“When the real economy desperately needs business investment and other productive uses of capital,” observed Leo Tilman, CEO of Tilman & Co., “it’s almost inconceivable that leading companies will conduct share buybacks to prop up equity valuations or increase executive compensation.”

With so many people getting infected and dying amid shortages of face masks and ventilators, naked capitalism no longer has much of an appeal. Example of how things have evolved: To only cursory public notice, last year, the Business Roundtable and the World Economic Forum in Davos called for expanding the purpose of the corporation beyond a focus on shareholders, expanding it to employees, suppliers, communities, and society at large.

“Some observers, including notable politicians, suggested that was just lip service,” Tilman said. “All of this has become very real,” thanks to the pandemic.

Unfortunately, not all companies that did buybacks could easily afford to. Case in point: American Airlines Group, which is a junk-rated BB- , until recently spent $1.1 billion of the $2 billion executives authorized for repurchases. It disbursed $600 million in this year’s first quarter.

The carrier’s long-term debt stands at $21.2 billion, and net debt is 4.5 times earnings before interest, tax, depreciation and amortization (EBITDA), by Goldman’s measure. (A company spokesperson said American’s priorities have been to pay down debt and invest in new planes.) In late 2018, Chief Financial Officer Derek Kerr said “our stock is undervalued.”

And now … The airline is applying for $12 billion in federal grants and loans. In the process, those sweet buybacks are fading into the night.


Related Stories:

Share Buybacks to Slide 15% in 2019 and 5% Next Year, Says Goldman 

Bye-Bye, Buybacks? Share Repurchases Falling 15%

Uh-Oh, Stock Buybacks Exceed Capital Spending in 2018


Tags
Coronavirus, Donald Trump, earnings per share, S&P 500, S&P Dow Jones Indices, stock buybacks, stock options,