by Ryan Frederick
Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)
Stock buybacks (or share repurchases – we will use the terms interchangeably) have garnered significant attention as publicly-traded companies have repurchased shares at record levels (in terms of dollars spent). In 2018, companies in the S&P 500 spent $806 billion on buybacks (about 3.8% of public float), shattering the previous record of $590 billion spent in 2007 (about 5.3% of public float) by 36.6%. Few topics provoke as intense of a response from those in the world of finance as to what role buybacks should play – whether in a given company’s cash management strategy or for the broader market as a whole. There are various viewpoints on the subject, but there’s a good chance you’ve primarily heard buybacks described in pejorative terms. The negative framing ranges from management using buybacks to manipulate EPS growth and share prices (with no underlying change in the company’s financial condition), to shortchanging long-term investments and employees, to cannibalization, to mis-spending tax cuts, to outright calls for the practice to be outlawed.
Indeed, it is easy to frame buyback programs in a negative light, and some of the connotations may be deserved. To be sure, corporate executives often focus so much on EPS performance that they might choose to engage in short-sighted and/or self-centered activities. (Whether they can get away with it is another matter.) However, the truth about buybacks is much more complicated than typically presented as there is a confluence of many factors and questions that must be considered, such as: What timeframe was used to analyze the effects? Was it the right timeframe? What are a company’s alternative investment opportunities before, during, and after a buyback program? Can an outsider refute with certainty what is/isn’t a good use of cash? What is the cost of capital and opportunity cost? What are the macroeconomic conditions, e.g., interest rates, fiscal policy, trade wars?
Moreover, do buybacks actually lift a given company’s share price and the value of an index that holds it? Is this practice such an epidemic and scourge on society that the federal government should step in to regulate what a private company (or by extension, its shareholders) can or cannot do with its cash? Should a buyback intended to reduce public float be made illegal once again (as it was until 1982)? We believe the answers to these questions are more nuanced than the media presents, so we will attempt to offer some additional insight. Read on….
By Brent Miller, CFA