What to know about stock buybacks, a new area of debate
It seems like everything is getting politicized these days. Now it’s the turn for stock buybacks, with everyone from President Joe Biden to billionaire Warren Buffett weighing in.
Buybacks, or share repurchases, would seem fairly noncontroversial. They are simply one of several ways that companies can deploy extra cash. Rather than paying a bigger dividend, reinvesting into the core business or acquiring another company, many executives prefer to repurchase their own stock, thereby reducing the number of shares trading.
With fewer shares outstanding, a company’s earnings per share will increase, all else equal. That could lead to a higher stock price.
Larger public corporations have pursued buybacks for decades, but the debate around them has intensified lately. For example, President Biden criticized companies that repurchase their own stock in his State of the Union address in February, while billionaire investor Warren Buffett defended the practice in his most recent Berkshire Hathaway annual-report letter to shareholders, also in February.
Buybacks emerged as a political issue even before that.
The Inflation Reduction Act, enacted last August, imposed a 1% excise tax on companies that repurchase $1 million or more of their shares, starting in 2023. Earlier this year, Commerce Secretary Gina Raimondo said technology companies that avoid buybacks for five years will have better chances of obtaining funding under the CHIPS and Science Act.
What are stock buybacks?
Buybacks are a simple concept. By repurchasing some of their own stock, corporations make the remaining, outstanding shares more valuable, with higher earnings per share a common result. It helps if management views the company’s share price as fairly valued or even undervalued when it initiates a repurchase program. You don’t want to buy up shares at a lofty price.
“The math isn’t complicated,” Buffett stated in his letter, noting Berkshire Hathaway’s recent pattern of repurchasing 1% to 2% of the company’s stock. “When the share count goes down, your interest in our many businesses goes up.”
One nice thing about buybacks is that shareholders big and small can benefit. Another aspect that makes buybacks attractive is that they can happen at various times and don’t need a scheduled continuation. Cutting a quarterly dividend, by contrast, is viewed as an unfavorable development that reflects poorly on a company’s future prospects and, thus, is a step that top executives like to avoid.
How do buybacks and dividends compare with stock buybacks?
Both buybacks and dividend payments have risen in importance. Big corporations in the Standard & Poor’s 500 index shelled out $982 billion for buybacks and $552 billion for dividends over the 12 months through Sept. 30, according to Howard Silverblatt, a senior analyst at S&P Dow Jones Indices. Both totals were up sharply over the yearearlier period. Apple, Alphabet, Meta, Microsoft and Lowe’s are among the biggest stock buyers.
Buying back shares often is contrasted against paying dividends, though many corporations do both. One key edge for buybacks involves taxes. Investors who hang onto their stock after a reduction in the outstanding shares could see a rise in EPS and a higher share price, yet no taxes are due until they sell.
That’s not the case with dividends. Those payments are taxable when received (though shareholders can work around this by holding their stock in sheltered vehicles such as an Individual Retirement Account). Some investors, especially those who fall in high tax brackets, might not want to receive dividends. Also, some dividends are taxed at higher rates than the long-term capital-gain rates that investors can qualify for when they sell shares, possibly many years down the road.
Why are stock buybacks controversial?
The debate over buybacks isn’t just about how corporations should deploy their cash. It also touches on other issues, including jobs and executive compensation.
Senate Majority Leader Chuck Schumer, D-N.Y., said in August he would like to see buybacks abolished, describing them as one of the most “self-serving things that corporate America does.” Schumer instead called on large corporations to use the money to invest in their businesses by, for example, spending more on worker training and research.
Democrats have proposed raising the newly enacted excise tax to 4%, though that seems unlikely to happen in a divided Congress.
But Jesse Fried and Charles C.Y. Wang, professors at Harvard Law School and Harvard Business School, respectively, argue that corporations should repurchase more shares, in part to reduce corporate “bloat” that can show up in, among other things, higher CEO pay.
“Because CEO pay is tied closely to a firm’s size, this bloating will drive up executive compensation,” they argued in a Wall Street Journal editorial that also asserted that there’s no evidence that dividends and buybacks have starved corporate America of cash. If anything, many companies still hold too much cash, they argued.
Excess cash also can lead to ill-advised moves such as acquiring other companies at excessively high prices or purchasing entities that don’t fit well with the existing business.
A good problem to have
The backdrop for the political debate over buybacks is that many corporate giants are generating huge amounts of cash flow and profits right now. That’s generally a good problem to have, and top executives should use the money as they see fit.
The arguments in support of buybacks seem more compelling than the criticisms, especially when made by politicians who have shown a lack of ability to manage the federal government’s own finances.