Stock buybacks, good or bad? They’re both

Are stock buybacks good for investors or just one more way that big money exploits ordinary people? Answer: both.

Stock buybacks can be a way for corporations to share the benefits of excess cash receipts and for a company to “invest in itself.” Alternatively, it can be a way for a corporation to manipulate its stock price and provide a cushy, tax-advantaged bonus to its top executives.

And, like Schrödinger’s cat in the magical world of quantum physics, stock buybacks can be on both good and bad ledgers at the same time.

When a corporation buys back some of its own outstanding shares of stock, that action often prompts a rise in the market price. This is due to three factors: psychology; economics; and investor decision criteria.

The psychology aspect comes not only from the past market behavior, which has been that the stock price rises when the buyback is implemented, and the assumption that the corporation is flush with cash, which is a good position to be in. The buyback is also often believed to reflect management’s confidence in the performance of and prospects for the company.

The economics dimension comes in when the corporation becomes another active buyer in the open market. This tends to give an upward push to the price. In the aggregate this can become a factor in economic policy and our economy’s performance.

Stock buybacks also have an indirect effect on economic policy and economic growth. Stock market prices are a “Leading Economic Indicator” which affect not only economic policy decisions but also the overall level of confidence in the economy and its prospects.

Investors, whether they are individuals, fund managers, or robotic auto-buy/auto-sell programs, make their market decisions based in large part on key corporate indexes such as “EPS,” earnings per share. Stock buybacks have a direct, positive effect on EPS, because they leave corporate earnings unchanged while reducing the number of outstanding shares – the divisor in the earnings per share. Depending on the buyback size, this could be a significant factor in the apparent health of a corporation.

The upward push in earnings per share isn’t the only balance sheet effect of a stock buyback. Return on Assets (ROA) goes up, because cash, an asset, is reduced and corporate earnings remain unchanged.

Until recently, few people outside of Wall Street paid much attention to stock buybacks. There was little reporting of them in the news media, partly because once the subject of accounting-speak like “balance sheet effects” pops up half the audience immediately turns the page in the newspaper or reaches for the TV remote. And hard data on buybacks still isn’t tallied by federal regulators.

That all changed when the huge size of stock buybacks became better known. Last year, for example, corporations in the S&P 500 made stock buybacks totaling $806.4 billion — enough to deserve attention.

The attention hasn’t been all positive. After all, this is a year of political campaigns. Senators Bernie Sanders and Chuck Schumer want to limit or ban stock buybacks and have portrayed American corporations as greedy, self-indulgent and promoting shareholders’ and management’s interests above those of all other stakeholders, including workers.

Goldman Sachs, on the other hand, sees a ban on stock buybacks as an economic disaster and the end of the world as we know it.

They are both right…a little. Corporate management is often self-absorbed but frequently its objectives coincide with those of both shareholders and the public. That remains the beauty and the benefit of free market competition.

Stock buybacks are a payout bonus for top managers that is taxed at a lower rate than if it were paid in cash. The same share price uptick that accompanies buybacks is the icing on the cake. But it is icing that all shareholders enjoy, not just top management. A recent research report found that stock buybacks were the dominant factor in the net return to investors. In short, those whose nest eggs benefitted from the bull market have stock buybacks to thank.

Even though stock buybacks aren’t evil and corporate management is not an agency of Satan, there is a scent of market manipulation about it that is worrisome. Both CEOs and shareholders themselves often seem obsessed with short-term stock prices and that is not healthy for long-run business health and growth. “Increasing shareholder value” can be a blanket excuse for a dead-end business strategy. We need only to look at General Electric’s history to understand how that works.

Congress often works in mysterious ways. But if the issue isn’t politicized beyond recognition the attention being given to stock buybacks could end up being a good thing, especially if it improves the sketchy data that currently surrounds the practice.