Loews Corp. CEO Jim Tisch faces a constant dilemma. When his company’s shares are cheap, he agonizes about whether to sound off about it — or stay quiet and just buy back a bunch of stock.
Last year, Tisch mostly did the latter, repurchasing more than 20 million shares, or some 6 percent, of Loews stock for about $1 billion. On the company’s fourth-quarter earnings call in February, he called buybacks “one of the best ways to create value for all our shareholders.”
For decades Tisch, who with his extended family owns more than 30 percent of Loews, has bought gobs of shares in the conglomerate founded by his father and uncle, eminent value investors and philanthropists Larry and Robert Tisch. Goosed by buybacks, Loews generated a return of some 17 percent from 1965 through 2018, versus 10 percent for the S&P 500. Just since 2008, Loews has reduced its share count by 41 percent.
The rest of corporate America seems to have taken a page from the Loews playbook. S&P 500 companies have been buying back dizzying amounts of stock, hitting a preliminary record of $797.9 billion in 2018, more than 70 percent of the index’s combined earnings, according to S&P Dow Jones Indices. The fourth-quarter total of $214.5 billion buybacks represents the fourth consecutive quarterly title topper.
Analysts call the stock repurchase phenomenon “staggering,” and sober investors talk of an out-of-control “buyback craze.” Media outlets regularly report that the same repurchases are pumping high-octane fuel into the current bull market, perhaps building up a dangerous bubble.
“What we see here is mindless short-term thinking,” says Dennis Kelleher, president and CEO of Better Markets, a Washington, D.C.–based advocacy group that promotes financial reform and transparency. “All these stocks didn’t magically become cheap last year. All they are doing is shoveling a tax windfall out the door.”
Lately, a new, and noisier, breed of critics has waded into the fight: populists.
Big share repurchasers are suddenly being branded as Public Enemy No. 1 by politicians, market reformers, and other activists, who blame buybacks for underinvestment in plant and equipment, low productivity, and stagnant wage growth — not to mention rising income inequality.
For all the foment, stock buybacks are not crack. Yes, they are spreading like an epidemic, but they aren’t new, and select companies have sound reasons for employing them — and it’s not always to enrich their executives.
As buyback critics sharpen their pitchforks, it’s increasingly clear that they are eager to make hay for blatant political ends — expanding the shareholder rights and corporate governance discussion to include worker pay, health care, and social justice. This isn’t wrong per se, but it’s missing the really juicy stuff.
The anti-buyback crowd doesn’t dwell on the clear evidence that companies that buy back their own shares tend to do so at the worst possible time. How is that different from ill-considered job-destroying mergers?
They also mostly ignore the way some companies use buybacks to artificially increase executive compensation.
“It’s almost the definition of stock manipulation,” says Better Markets’ Kelleher. “There should be a high bar for companies to engage in stock buybacks.”
Populist-driven anti-buyback fervor is sweeping the presidential campaign trail — on both sides. Senator Elizabeth Warren of Massachusetts, who is running to be the Democratic presidential candidate, has called buybacks “a sugar high” for corporations.
Senators Chuck Schumer of New York, the Democratic Senate leader, and Bernie Sanders of Vermont, another 2020 would-be presidential candidate, decried the rising tide of buybacks in a joint New York Times opinion piece in February and said they would introduce legislation to rein it in.
Their bill would prohibit companies from repurchasing shares unless, among other things, they paid their workers at least $15 an hour.
“If corporations continue to purchase their own stock at this rate,” the two Brooklyn natives warned, “income disparities will continue to grow; productivity will suffer; the long-term strength of companies will diminish.”
Scarcely more than a week later, Republican Senator Marco Rubio of Florida joined in with a series of tweets: “Why are profits not being invested into company or new companies?” He tweeted out a promise to introduce a bill to make the tax treatment of buybacks similar to that of dividend payouts: “No tax advantage for buybacks over dividends.”
Stock market indexes sold off after Rubio’s tweet. And pundits quickly took to the air to remind the public of value-destroying buyback train wrecks like General Electric Co. and Sears Holdings Corp.
“Buybacks have just become super-politicized,” said David Larcker, a professor of accounting at Stanford Law School and director of Stanford business school’s Corporate Governance Research Initiative.
Perhaps everybody should exhale. Sure, the Trump administration’s $1.5 trillion 2017 tax overhaul, which cut corporate rates to 21 percent from 35 percent, has helped push buybacks to record levels. But share repurchases have been mounting now for a decade and are fed by myriad factors, ranging from changes in U.S. tax rates and policies to a constrained economic recovery and a low-interest-rate environment.
The noise surrounding buybacks is to the point where it is drowning out serious discussion of stewardship, corporate governance, executive compensation, and alleged stock price manipulation. Hedge fund wags at AQR Capital Management LLC even published a study entitled “Buyback Derangement Syndrome.”
Still, a couple of things need to be cleared up.
Buybacks are not a meaningful factor in the surging stock market. “That’s baloney — the bull rally is confidence in the economy,” says finance professor Charles Elson of the University of Delaware. “Over time the markets are efficient.”
Indeed, it’s easy to overstate the market impact of buybacks. A chunk of the repurchases — how big is open to debate — is made to offset the dilution of options and restricted stock grants. A company’s overall share count remains the same as the acquired stock is shunted into Treasury or retired, balancing out the grants and exercised options.
The share repurchases that concern most people are the discretionary ones authorized by company boards beyond the amount required to offset dilution. Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, calculates that overall, S&P 500 year-over-year share count reductions amounted to 3.7 percent in the fourth quarter of 2018. That’s significant, but not enough to fuel a rally of consequence.
Silverblatt found that 19.3 percent of S&P 500 companies reduced their shares by 4 percent or more in the fourth quarter, versus 17.7 percent in the third quarter, 15.6 percent in the second, and 13.6 percent in the first. So the buyback bandwagon accelerated in a meaningful manner as 2018 progressed.
Granted, buybacks and the announcements that accompany them may cause a temporary bump in a company’s stock market capitalization, but studies show that impact soon dissipates. “A company can support its stock short-term,” says Silverblatt. “Long-term the market decides.”
Ultimately, the relevant math is that in a buyback, a single share will rise in price, but only because it represents a larger slice of what is essentially the same pie, minus some cash spent on the buyback. The company’s overall stock market value arguably remains pretty much the same, if not slightly lower.
On the other side of the coin, articles breathlessly warn of the growing volume of buybacks. “That completely obfuscates the fact that the number of buybacks has gone up because the market cap has increased,” notes Matt Bartolini, head of SPDR Americas research at State Street Global Advisors.
A January report that Bartolini co-authored points out that the growth in buyback volume has closely tracked that of the market capitalization of the S&P 500 for the past 15 years. That said, the S&P 500 buyback yield — the value of buybacks divided by the index’s market cap — stood at a preliminary 3.79 percent in 2018, a level it has seldom flirted with since the financial crisis, according to S&P Dow Jones Indices.
Still, the U.S. is not running out of equities anytime soon.
Perhaps the biggest beef of buyback critics, at least from the asset allocation perspective, is that the money used to pay for buybacks would otherwise have been channeled to more productive purposes, like capital expenditures, R&D, acquisitions, or perhaps, God forbid, better worker pay and benefits.
The evidence doesn’t say so. Drawing on data from 1988 through 2016, Ric Marshall, executive director of MSCI’s environmental, social, and governance research team, examined 610 companies in the MSCI USA Index, which overlap with those in the S&P 500. Capital expenditures for the MSCI companies peaked in 1997 at 8 percent of assets, before steadily tumbling to less than 4 percent at the end of 2016. As for R&D, it peaked in 1998 at nearly 4 percent of assets, falling to just over 2 percent in 2016.
Stock buybacks, meanwhile, rose during that nearly 30-year span, roughly quadrupling to more than 4 percent of assets by 2016. (Dividends were, ultimately, more or less flat during the period, beginning and ending at 2 to 3 percent of assets.)
The takeaway: The decline in capital expenditures and R&D was far greater than the increase in buybacks. That suggests other factors were affecting capital expenditures and R&D — say, a declining industrial base, increased productivity, offshoring, or the shift to service-based and gig economies.
For buyback adversaries a good question to ask may be where companies can expect to earn a decent return on capital expenditures in our current environment, especially given the tepid economic recovery since the 2008–’09 financial crisis. “It’s not the case the more investment the better,” says professor Wei Jiang of Columbia Business School. “You only invest when there is positive net present value.”
The companies in large-capitalization indexes like the S&P 500 are often mature businesses, ones that no longer need large amounts of capital. “I don’t think there’s a lot of evidence that there are opportunities they are not pursuing,” says Steven Fazzari, a professor of economics and sociology at Washington University in St. Louis.
What buyback critics ignore is that when companies return capital, underutilized money gets handed over to investors to either spend or recycle into new capital-hungry ventures, a virtuous capitalist ecosystem.
“Do they really want the CEOs and managements and boards to be making all the decisions as to where that money is being deployed rather than returning it to investors to be reinvested?” asks MSCI’s Marshall. It’s almost as if critics feel more comfortable with a misguided, job-destroying merger than a robust buyback authorization.
Meanwhile, shareholders, management, and boards have all found plenty of reasons to view buybacks in a more favorable light than old-fashioned dividends.
Take the buyback-versus-dividend challenge. Most investors favor buybacks over more traditional payouts because they can treat the eventual profit as capital gains. Although the tax rates are similar, at either 15 or 20 percent in 2018, with buybacks investors get to determine when they sell their stock to take the gain, allowing them to postpone taxes in perpetuity or use capital losses to offset them at a time of their choosing.
For management, buybacks are a far more flexible way to return money than dividends. The share repurchase programs companies routinely authorize are discretionary — so they can generally stop buying on a dime, without public notice, and most investors will be none the wiser.
Contrast that with the brouhaha of a dividend cut at a large U.S. multinational, which could very well make the front page of The Wall Street Journal and is likely to send company shares diving.
There’s a little bit of unfairness in the comparison. Though most big companies use a combination of buybacks and dividends to return capital to shareholders, note that it’s only the former that have come under criticism. Nobody is eager to to denounce the quarterly dividend checks our parents and grandparents lived off of.
The buybacks are helping companies reduce their cash — something of a red flag for activist investors who are particularly sensitive to the meager interest being earned by such holdings. Example: Third Point’s 2017 targeting of Nestlé, in which Dan Loeb pushed increased productivity, asset sales, and enhanced share buybacks, and a more leveraged balance sheet for the food juggernaut.
Nestlé cut cash and equivalents to SFr4,500 million in 2018, from SFr7,938 million in 2017. A new share buyback plan, which the company says it was preparing before Third Point’s arrival, is expected to be completed six months early.
The irony of all this general happy talk is that stock buybacks have dark corners that critics could be exploring. For example, one thing that companies buying back shares certainly aren’t focusing on is the price they pay — a gob-smacking oversight in a discipline that, in the end, is all about dollars and cents.
CEOs like Tisch and, more famously, Berkshire Hathaway’s Warren Buffett, carefully calibrate purchases so as not to pay more than the stock’s so-called intrinsic value — its true worth — which is ultimately a subjective calculation.
Accordingly, Loews bought back a modest $134 million of stock in 2016, for an average price of $38.96, and $237 million worth of stock in 2017, for an average of $49.76 a share.
In 2018, Buffett, with $111.9 billion in cash on Berkshire’s balance sheet, purchased just a handful of shares over two short spans. In October he bought 202 class A shares at an average price of $310,762.79 and 589,955 class B shares at an average of $205.09. In December he bought 790 class A shares for an average price of $295,953.99.
“Obviously, repurchases should be price-sensitive,” Buffett wrote in his 2018 shareholder letter, released last month. “Blindly buying an overpriced stock is value-destructive, a fact lost on many promotional or ever-optimistic CEOs.”
Such optimists, however, seem to throw parsimony to the wind when it comes to buybacks.
For example, in 2000, the year that tech stocks peaked, S&P 500 corporate stock buybacks hit $150.6 billion, according to S&P Dow Jones Indices. By 2002, when the bear market bottomed, share repurchases fell to $127.3 billion.
History repeated in 2007, as share repurchases hit a then-record $589.1 billion. In 2009, a great time to buy amid the wreckage of the financial crisis, they fell to $137.6 billion.
Now buybacks have zoomed to some $800 billion. Do we really need to ask what happens next to these buybacks given the run-up? “Usually, they are poorly timed,” says Elson of the University of Delaware.
“It’s about the cycle,” notes Bartolini. “Companies have capital to return to shareholders at the top of the economic cycle.”
This leads to a natural question: Do buybacks increase shareholder value? Or, to use Buffett’s term, are they “value-destructive”? The answer is that it can be devilishly hard to answer.
“You have to do the valuation internally,” says Stanford’s Larcker. “It does force you to confront what a company is really worth. Is it credible or is it Pollyanna?”
In hindsight, unless a company utterly crashes or is taken out at a sky-high premium, it can become a question of judgment — do you compare returns to those of similar companies, to an index, or by some other metric? With a complicated company or conglomerate, it can seem like anybody’s guess.
Says Deutsche Bank insurance analyst Joshua Shanker, “It’s not a slam dunk that all of the purchases of stock have been accretive to value at Loews.”
Did we mention that companies use stock buybacks to artificially increase executive compensation? The evidence sure suggests some do — and here’s how.
Before 2014 heavy machinery maker Caterpillar used a formula for its executive compensation based on an equal weighting of 50 percent total shareholder return and 50 percent return on assets, according to a letter sent to shareholders by CtW Investment Group, which works with union pensions to investigate unethical corporate behavior. When management failed to meet lowered performance targets using that metric, CtW pointed out, the compensation committee switched to a different mix — just 25 percent total shareholder return and 75 percent earnings per share for Caterpillar’s 2014 to 2016 compensation cycle.
Caterpillar’s performance declined in 2014, but the company more than doubled its share buyback plan for the year, spending $4.2 billion on repurchases.
The company reported earnings per share of $5.88 for 2014, versus $5.75 for the year earlier, and commended management for effective cost control and execution. Without the buybacks, however, earnings per share would have declined by 2.5 percent, according to CtW calculations.
And then-CEO Doug Oberhelman’s compensation rose 14 percent, according to CtW. In 2016 the company announced that Oberhelman would be retiring the following year. Caterpillar did not respond to a request for comment in time for publication.
Partly as a result of Caterpillar’s machinations, says John Roe, head of ISS Analytics at Institutional Shareholder Services, shareholders have sought to force boards to fix the number of shares used in the calculation of compensation at the start of the year, or to otherwise prevent manipulation. “There is more of a focus on hygiene, for want of a better word,” he explains.
Companies like IBM Corp. disclose in their proxy statements the specific steps they take to limit the effects of buybacks on earnings-per-share–based compensation metrics.
Many more keep their methodologies under wraps, according to Julian Hamud, director of executive compensation research at Glass, Lewis & Co. “We have companies that don’t say anything at all,” he notes.
All the controversy surrounding buybacks may cause investors to overlook perhaps the most important dynamic at work. The only reason we’re debating stock buybacks is that companies are minting money as never before.
“The reality is that companies are only able to buy back shares because they are generating free cash flow,” says MSCI’s Marshall. “They are not diverting money — they are rolling in dough.”