Stock buybacks continue to make headlines.
But not like they did eight years ago, when Traders Magazine reported companies were employing analysis to decide when to buy back their own stocks. Nowadays, stock buybacks are being lamented by government politicians as artificially manipulating stock prices and inflating company valuations.
In recent remarks, several prominent politicians have openly questioned corporations buying back of stock – saying it serves only as an earnings boost and helps the company and not mom-and-pop investors or Main Street. This buyback money, they argue can be better used to pay workers increased salaries and address other quality of life issues.
Richard Thornburgh, senior advisor of Corsair Capital, took two of the most prominent critics of stock buybacks, Sens. Chuck Schumer and Bernie Sanders to task on the issue of stock buybacks. He cited a recent op-ed in The New York Times on corporate stock buybacks, where Senate minority leader Chuck Schumer (D-New York) and Sen. Bernie Sanders (I-Vermont) claim that stock buybacks dont benefit the vast majority of Americans and nearly 85% of all stocks owned by Americans belong to the wealthiest 10% of Americans.
The senators reference the $4 trillion of share buybacks completed from 2008 to 2017 by 466 of the S&P 500 companies. It is important to understand that this very large amount of cash did not vaporize, nor did it benefit just a small handful of people. Rather, it was used to positively impact the U.S. economy overall, Thornburgh said on CNBC. An Economics 101 class teaches us about the multiplier effect – every time there is an increase in spending, it produces an increase in national income and consumption greater than the initial amount spent.
Thornburgh explained that Stock buybacks are an excellent example of this effect at work. As shares are repurchased, the cash is used in a productive manner that benefits many Americans, from both the reinvestment of the proceeds or the spending of the distribution of the proceeds.
Investors can use the cash for a variety of investment opportunities. For example, they can invest in an initial public offering to support a growing business, purchase U.S. Treasurys to finance government spending activities, investing in a corporation or municipality by purchasing its securities or support home ownership in America by purchasing mortgage-backed securities.
So, who owns American equities?
According to the Federal Reserve, ownership of American equities breaks down as follows:
Households and non-profit organizations: 39%
Funds (mutual funds, closed-end funds, exchange traded funds): 30%
Foreign investors: 15%
Public and private retirement funds: 12%
Insurance companies: 2%
U.S. banks and broker dealers: 1%
U.S. governments (federal, state, municipal): 0.5%.
According to a 2017 Gallop survey, 52% of all Americans own shares through one form of the above classification.
If more than half the population owns shares, it is patently false to presume, as the two senators do that when a company purchases its own stock back, it reduces the number of publicly traded shares, boosting the value of the stock to the benefit of shareholders and corporate leadership, not workers.
According to the Gallop survey, 62% of adults between the ages of 30 to 64 are shareholders and, therefore, benefit from an increase in the value of the underlying stock. The same holds true for those with retirement savings through a corporate-sponsored pension or savings plan, individual retirement accounts or as part of a municipal, federal or teachers public pension plan.
In a recent feature, Nicolas Colas, co-founder of DataTrek, noted that S&P released their latest data on US stock buybacks and reviewed that data and came to the following conclusions:
#1. The headline numbers are off the charts.
Buybacks in Q4 2018 for the companies of the S&P 500 totaled $223 billion, a new quarterly high and 30% above the prior cycle top of $172 billion in Q3 2007.
For 2018, buybacks totaled $806 billion, up 55% from 2017. Last year was also meaningfully higher than both the current cycle top of $572 billion (2015) and the prior cycles $589 billion (2007).
Companies didnt only spend their windfall from lower corporate taxes on buybacks. Operating earnings grew by $216 billion last year from both tax cuts and business growth. Buybacks increased by $287 billion.
#2. Over half the growth in buybacks last year came from one sector – Technology – and 80% came from just 3 industries.
Tech industry buybacks grew by $160 billion in 2018, to $279 billion from $119 billion. This represents 56% of all 2018 buyback growth.
Apple alone is responsible for 14% of total growth in 2019 buybacks, with an incremental $40 billion in repurchases last year.
Health Care ($44 billion of incremental 2018 buybacks) and Financials ($26 billion) represent 15% and 9%, respectively.
These three sectors represent 80% of all growth in 2018 buybacks over 2017.
#3. Just as important as the top-of-house numbers: how did companies allocate their free cash flow between buybacks and dividends in 2018?
In 2019, S&P 500 companies used 63% of their operating earnings (post tax) on buybacks. This compares to a 50% average buyback payout ratio from 2010 – 2017.
So, how does Colas see it?
Our conclusion: buyback levels in 2019 should remain broadly consistent with 2018, but – and this is a big but – earnings have to remain constant to last year to make that happen, Colas. With buyback payout ratios at cycle highs and dividend + buyout ratios at 100%, there is simply no buffer. This important source of demand for equities (especially in Tech, Health Care and Financials) will flow with the earnings tide.
The following article appeared in the July 2011 edition of Traders Magazine
Corporate Buybacks On the Rise
By James Armstrong
Flush with cash but uneasy about the future, many companies are looking to buy back their own stock, providing one bright spot for brokers who have seen volumes decline in recent years.
Though trading in general is down, buybacks have been on the rise since 2010. Last year, stock buybacks by S&P 500 companies increased 117 percent to $299 billion, up from $138 billion in 2009.
During the first four months of 2011, U.S. companies unveiled an additional $195 billion in buybacks, according to research firm Birinyi Associates. More recently, Wal-Mart, Express Scripts and General Electric have all announced buybacks.
“Companies are still concerned about making capital investments, but they have an abundant amount of cash on their balance sheets,” said Jeffrey Yale Rubin, director of research for Birinyi Associates. “Buybacks are the way they’re going.”
Brokerage Cheevers & Co. recently expanded into corporate buybacks, bringing in a new trader who specializes in the space. Brett Klein has joined Cheevers from Northern Trust to help oversee its new corporate buyback service.
Klein is optimistic that buybacks will continue ticking upward, as they have since last year. “We’re not quite at levels we were at in early 2007, but right now volume-wise, we’re at about the same level as mid-2005,” Klein said.
Some companies have mandates requiring that a certain amount of their buyback activity be sourced to woman- and minority-owned firms. As Cheevers is woman-owned, it has an additional attraction for companies making buybacks, according to Klein.
One recent trend is that more company treasurers are setting up pre-arranged trading strategies, which allow them to legally sidestep blackout periods, Klein said. During a blackout period, companies are not ordinarily allowed to buy back their stock.
Corporations have about eight months out of the year when insider trading rules create blackout periods. However, under the SEC’s 10b5-1 rule, companies can set up a system to perform automatic stock buybacks during those times.
Treasurers are increasingly seeing these pre-arranged buybacks as a form of risk management, according to Klein. Should a company’s stock fall below a certain level, a planned trade will be executed buying back stock on the company’s behalf.
Cheevers is now using third-party provider Quantitative Services Group to design custom benchmarks for buyback trading, Klein said. Through QSG, the company can see what the volume-weighted average price is for trades made under the SEC 10b-18 safe harbor rule for buybacks, and then compare that to how clients’ trades are actually being executed.
“This benchmark through QSG has been a huge asset for us,” Klein said. “It’s really showing added value to companies that are focused on execution.”
Tim Sargent, chief executive officer of QSG, said his firm is working with the sellside and with companies doing buybacks to ensure best execution. “Increasingly in an era of high frequency trading and questions surrounding trade signaling and other kinds of slippage issues, these corporate managers want to make sure that games aren’t being played with the repurchase programs,” Sargent said.
A third-party provider can let companies performing buybacks know if costs are in line with the marketplace and whether or not the behavior of a stock is normal during buyback executions, Sargent said.
