Stock buybacks are good for corporate America, arent they? If so, arent they good for John Q Public and his 401K?
Not so fast. Nicolas Colas, co-founder of DataTrek explored the recent interest in corporate buybacks as they relate to politics and the recent rise of more progressive and social policies in a recent story. Here is the commentary as written by Colas:
In a recent New York Times Op-Ed, US Senators Chuck Schumer and Bernie Sanders outlined a forthcoming bill to address the crisis in American public company stock buyback programs. It would require any company to pay employees $15/hour, provide 7 days/year of paid sick leave, and offer decent pensions and more reliable health benefits. Yes, pensions…
Lest you think thats just one partys view on buybacks, Senator Marco Rubio was out today with a series of Twitter messages with his own ideas about how to curtail public company stock buybacks. In his words: Right now we dont have a free market. We have tax code which engineers economy in favor of inflating prices of shares at the expense of future productivity & job creation. His idea is to tax capital gains at the same rate as dividends. No word on whether this would be limited to just shares sold to a company or all cap gains…
We have 2 thoughts on this issue:
When the left and right agree on an issue, you have to believe some form of legislation will eventually pass. Thats especially true in the current political climate, when Democrats and Republicans do not seem to agree on anything.
Stock buybacks are deeply cyclical in nature, so the fact that their size has finally drawn DCs attention is a worrying sign of a corporate profit top. Legislation on financial issues is almost always reactive, not proactive.
As far as what this means for investors, 3 additional points:
#1. Buybacks have exceeded dividends as the primary method of how large US public companies return cash to shareholders since Q1 2010. Data for the S&P 500 here:
For the 12 months ending September 2018 (latest data available), buybacks totaled $720.4 billion versus $445.9 billion for dividend payments. That 161% ratio is higher than any of the last 3 years (124% in 2017, 35% in 2016, 150% in 2015).
Over the same trailing 4 quarters ending September 2018, the companies of the S&P 500 paid out 56% of their operating income through stock buybacks. That is higher than 2017 (49%) and 2016 (58%) but lower than 2015 (65%).
Only during/right after the Great Financial Crisis do you find dividend payments exceeding buybacks. This happened from Q4 2008 to Q4 2009. By Q1 2010, buybacks ticked higher than dividends ($55.3 billion vs. $49.3 billion), and they havent looked back since.
#2. Stock buybacks have absorbed all the natural selling in US equities over the last several years.
The Investment Company Institute reports the following net redemptions from US equity mutual and exchange traded funds over the last 3 years: 2016: -$67.5 billion, 2017: -$50.2 billion, 2018: -$114.2 billion. Total: $231.9 billion.
Over the same 3-year period, the companies of the S&P 500 bought back an estimated $1.8 trillion, or 7.7x what mutual funds/ETFs sold. Theres some fudge factor in this number (S&P buyback data vs. all US stock funds, an assumption that Q4 2018 buybacks equaled Q4 2017), but the magnitude of the difference is what matters. And it is very large.
#3. The fact that buybacks have become a bipartisan piata is a new trend but one worth watching, because whatever you think of buybacks they can often be better than the alternatives.
Excess corporate cash is something like a hammer in search of a nail. From a shareholder perspective, whacking away at buybacks is preferable to companies deploying that cash in suboptimal internal projects or (even worse) large acquisitions.
Big Tech is ground zero for excess cash and buybacks – limiting the latter could spur even more industry concentration by encouraging M&A.
Assuming the Schumer/Sanders bill only applies to US workers, companies who want to buy back stock would have more incentive to move more jobs offshore since they will face higher onshore labor costs. Even if the legislation locked-in the current workforce, incremental capital investment would naturally shift away from the US.
The bottom line to all this: were surprised at how quickly this issue has gotten a head of steam on it, and perhaps it is all DC theatrics. But barring a sudden recession that meaningfully reduces corporate cash flows and buybacks, it has legs if legislators want it to. Any real regulation on buybacks, either through labor conditions or tax code, is a negative for valuations and stock prices.
Sources:
Schumer/Sanders Op-Ed: https://www.nytimes.com/2019/02/03/opinion/chuck-schumer-bernie-sanders.html
Rubio Twitter Feed: https://twitter.com/marcorubio?lang=en
