February 5, 2023
Companies have been buying back their stock for years, and 2023 proves no different so far. According to Bloomberg, there were $132 billion of announced buybacks in January 2023, which set a record for announced buybacks at the start of a year. This was largely spurred by Chevron’s announcement of a $75 billion stock buyback. Meta also announced a $40 billion stock buyback on February 1, 2023. The stock market has reacted positively to the news, and shareholders stand to benefit, but are stock buybacks bad for employees or the economy in general? There seem to be mixed sentiments out there.
Stock buybacks are when a company uses cash to repurchase its shares from the open market. They can either repurchase the shares through a tender offer or directly buy the shares trading on the market. Once they repurchase the shares, they can either retire them or hold them as treasury stock, which can be issued later. By repurchasing the shares, the company is reducing the total number of its shares outstanding. This has the effect of increasing the ownership percentage of existing shareholders. It also increases earnings per share. Typically, the company’s stock price will receive a boost after a share buyback announcement. The market generally sees stock buybacks as a positive signal that the company is doing well, has enough cash to repurchase its shares, and believes in its stock. During this time of rising interest rates and general market uncertainty, the announced stock buybacks have given the market some confidence and offset some of the bad earnings news.
So why is there negative sentiment toward stock buybacks? There are a couple of reasons. First, the company is allocating its cash to repurchasing its stock when it could reinvest that money into the business. For example, that money could be used to increase employee compensation or invest in R&D. It looks bad from an optics standpoint when a company has mass layoffs or employees get pay cuts but then the company turns around and buys back a bunch of stock. Second, executive management often has incentive compensation tied to the company’s performance, including the company’s earnings per share. Therefore, executive management might be incentivized to do a stock buyback to increase earnings per share to meet their bonus targets. For these reasons, stock buybacks have received a lot of scrutiny from certain congressional leaders. Some senators have even demanded that companies be restricted from buying back their stock. Nothing like that has been passed, but as part of the Inflation Reduction Act of 2022, there is a 1% excise tax on stock repurchases effective January 1, 2023. However, this has not deterred companies from doing stock buybacks because the percentage is minimal.
Stock buybacks can have potential benefits too. The boost that shareholders receive can then be reinvested back into the stock market. Also, many people don’t realize how much stock companies issue over time, which can dilute stock ownership. Many companies, especially tech companies, issue large amounts of stock through employee share-based compensation. Stock buybacks help to offset that dilution. Furthermore, employees with share-based compensation can also benefit from an increase in stock price, although the executives also stand to gain the most from that perspective.
Stock buybacks in themselves are not bad. It comes down to how effective companies are at it and if they are doing it for the right reason. Typically, stock buybacks make sense for companies that are not high-growth, have lots of cash on hand, and their stock is undervalued. It doesn’t make sense to repurchase stock when the price is high. It is also a red flag if the company uses debt to fund the stock buyback or if there are better ways to invest the cash. In certain circumstances, stock buybacks can have a large impact on shareholder value and the stock price. Some companies that have aggressive stock buybacks and reduce their total outstanding shares by 60% or more have enjoyed huge gains in their stock price even though they haven’t had much growth.
At the end of the day, many companies weigh the cost and benefit of doing stock buybacks. There is a lot of analysis behind their capital budget allocation decisions. Some companies have treasury departments that can implement more sophisticated share repurchase programs like Accelerated Share Repurchases (ASRs). In general, these stock buybacks are calculated and not a cheap trick. From that perspective, it’s best to leave it to the companies to determine how they use their cash.
