In recent times many U.S. publicly held corporations have taken advantage of easy money policies by the Federal Reserve to buy back their own stock from the open market.  In the short term this generally provides a boost to the price of a stock as fewer shares are on the market for sale.  But what are the long-term ramifications, and are they healthy for the company’s shareholders.

  1. Not an investment: A corporate stock buyback is never an investment in the company that buys its own stock.  A buyback does not provide a return or windfall of resource to the company other than probably causing some temporary artificial buoyancy to the price of its shares.  If it were an investment, it would provide the company, taken as an entity, with some type of financial benefit such as newer plants and equipment, new products to sell, or other considerations for carrying on with the business.  Further, a buyback diverts resources away from standard investments that perhaps the company needs, such as hiring employees or buying inventory.  Financial accounting disclosure does not permit stock buybacks to be recorded as investments, but instead as offsets to the amount of equity owned by shareholders.
  2. The Resources are trapped: As a resource, the money used to buy back a company’s stock is considered gone from the company as if it were additional payroll or bonus to employees and executives.  To regain the resources the company must sell the stock back into the open market thereby reversing the original transaction.  This action should force the price downward, thereby defeating the purpose of the buyback to begin with.
  3. Retiring the stock is usually not an option: Most corporations issue stock at a very small stated value versus the market value that the stock was worth when it was bought back.  When the stock is bought back from the open market, there is almost always a massive premium that comes with it.  This premium that the company pays is buried against the shareholder’s equity.  To retire the stock, the company must therefore recognize a massive loss on its financial statements, since the money paid for the stock shares in the open market dwarfs what it was worth when issued.
  4. Incurring debt to enable buybacks: One astonishing aspect of this era of easy money is the number of corporations that borrow money in the marketplace at the same time as they execute stock buybacks.  Those companies are in effect swapping out equity for debt just to artificially prop up the price of the company’s stock.  For most of the last decade the Federal Reserve has taken steps to make capital easier for U.S. corporations to acquire via interest rate reductions and quantitative easing (increases to the money supply).  I doubt that very many U.S. corporations would have undertaken such huge amounts of stock buybacks if monetary policy were a lot tighter.
  5. Some U.S. corporations have more buybacks than assets: Some large, famous, corporations have spent more resources into buybacks than they have available in total assets.  That technically could mean that if the company had not executed the stock buybacks, they would have had up to twice as much money and resource available for any other purpose.  The below list shows the percentage of total assets that total buybacks amount to for selected companies as of the end of 2018:

Applied Materials  (AMAT)                                       120%

Bed, Bath, & Beyond (BBBY)                                 162%

CBS Corporation  (CBS)                                            105%

eBay  (EBAY)                                                            116%

Home Depot  (HD)                                                     132%

IBM  (IBM)                                                                136%

IDEXX Laboratories  (IDXX)                                   149%

Intuit  (INTU)                                                             215%

McDonald’s  (MCD)                                                  188%

Papa John’s International  (PZZA)                             126%

Texas Instruments  (TXN)                                          187%

Zix  (ZIXI)                                                                  206%

  1. Alternatives to stock buybacks: What alternatives would there be to stock buybacks that could benefit shareholders?  For the last five years IBM has accumulated more buybacks than total assets ranging up to 136%.  During that time its stock price has fluctuated from a high of $193.26 on September 18, 2014 to a low of $107.47 on December 21, 2018.  The stock closed on August 13, 2019 at $135.79.  In this case, where are the benefits to the shareholders provided by the major spending on buybacks?  How would the stock price have fared if instead of buybacks, the company provided that amount of money in extra dividends?  How would the company’s future fare if that money had been spent on research and development for new products, paydowns of existing debt, buyouts of leases, or updates to plant and equipment throughout the organization?  For the amount of its buybacks IBM could have purchased whole companies, expanding their business in new directions.  Intuit could have bought two whole companies the same size as Intuit is today.

Summary:  Like certain drugs or a sugar high, corporate stock buybacks are at best a short term benefit to the financial well being of the company.  They have a tendency to artificially prop up the price of the stock.  All too often this is done to suit corporate officers who need certain price returns to maximize their own bonus potential.  In the long run, the resources are mostly consumed permanently since the only way to recoup them is to sell the stock back into the open market defeating the greater purpose.

Sources:  Charles Schwab and Company

 

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