Some stock buybacks come out smelling like anything but roses,
Buybacks reduce a company’s share total, giving a lift to earnings per share — in theory
Anyone who made it through the crash of October 1987 probably recalls the boost provided by share-buyback announcements.
Following the collapse back then, big corporations stepped up with word that they would buy back their shares. Nearly two in five companies in the Standard & Poor’s 500 index declared they would purchase stock, helping to reassure rattled investors with a message that prices had dropped to bargain levels.
Ever since, investors generally have viewed buybacks favorably, though some recent research suggests buybacks don’t always help all that much.
Share buybacks often are mentioned in the same favorable breath as dividend increases as a tool management can use to boost returns for shareholders. Buybacks reduce a company’s outstanding share total, giving a lift to earnings per share.
Compared with paying dividends, buybacks have certain advantages. One is flexibility, as companies can pursue buybacks as one-time actions, with no expectation they will continue into the future. That’s not so easy to do with dividends, where decreases and cuts are viewed with alarm. Buybacks also can enrich shareholders without saddling them with a tax bill. So what’s not to like? The common presumption is that buybacks are good because they remove shares from the market. But if the same corporations also are issuing new stock separately, that would mitigate the benefits, Chris Brightman, Vitali Kalesnik and Mark Clements at investment-strategy firm Research Affiliates wrote in an October study.
Why would companies issue new shares? One reason is to finance executive compensation as CEOs and other top corporate officials exercise stock options.
“When management redeems stock options, new shares are issued to them, diluting other shareholders,” the authors note. “Buyback? Not really! Management compensation? Yes.”
Another reason is to pay for acquisitions of other companies. With some deals, issuing new stock to make the purchase can dilute or erode the value of shares already outstanding. The purchase of one public corporation by another generally wouldn’t make much of a net impact because new shares of the one entity are being used to retire those of the other. But buying a private company with new stock, as with Facebook’s acquisition of Whats App, would represent new issuance and thus dilution.
Further, corporations sometimes buy back shares at the same time they are increasing debt, which can make a company more risky. Several giant companies that had some of the largest buybacks last year also engaged in some of the biggest stock issuance, including Cisco, Oracle, Johnson & Johnson, Wells Fargo and Merck.
The researchers take a swipe at the occasional practice of adding a company’s buybacks and dividend yield together to generate a performance measure for shareholders. With buybacks repre- senting 2.9% of the capitalization of S&P 500 companies and dividend yields at 1.9%, that suggests a combined 4.8% yield for shareholders.
But this number fails to include new issuance that offsets most or all of the former number.
“We do not think that the naïve sum of dividends plus buybacks has merit,” the authors said.
Taken together, the report sees little overall benefit from buybacks for mainstream investors.
“The reality is that publicly traded companies in the United States are issuing far more new securities than they are buying back,” the authors say. “In the aggregate ... buybacks are simply a mirage.”