Stock buybacks, good or bad? They’re both

There is a scent of market manipulation about the practice that is worrisome.

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.

Talk to us

> Give us your news tips.

> Send us a letter to the editor.

> More Herald contact information.

More in Business

Simreet Dhaliwal speaks after winning during the 2024 Snohomish County Emerging Leaders Awards Presentation on Wednesday, April 17, 2024, in Everett, Washington. (Ryan Berry / The Herald)
Simreet Dhaliwal wins The Herald’s 2024 Emerging Leaders Award

Dhaliwal, an economic development and tourism specialist, was one of 12 finalists for the award celebrating young leaders in Snohomish County.

Lynnwood
New Jersey company acquires Lynnwood Land Rover dealership

Land Rover Seattle, now Land Rover Lynnwood, has been purchased by Holman, a 100-year-old company.

Szabella Psaztor is an Emerging Leader. (Olivia Vanni / The Herald)
Szabella Pasztor: Change begins at a grassroots level

As development director at Farmer Frog, Pasztor supports social justice, equity and community empowerment.

Simreet Dhaliwal is an Emerging Leader. (Olivia Vanni / The Herald)
Simreet Dhaliwal: A deep-seated commitment to justice

The Snohomish County tourism and economic specialist is determined to steer change and make a meaningful impact.

Nathanael Engen, founder of Black Forest Mushrooms, an Everett gourmet mushroom growing operation is an Emerging Leader. (Olivia Vanni / The Herald)
Nathanael Engen: Growing and sharing gourmet mushrooms

More than just providing nutritious food, the owner of Black Forest Mushrooms aims to uplift and educate the community.

Owner and founder of Moe's Coffee in Arlington Kaitlyn Davis poses for a photo at the Everett Herald on March 22, 2024 in Everett, Washington. (Annie Barker / The Herald)
Kaitlyn Davis: Bringing economic vitality to Arlington

More than just coffee, Davis has created community gathering spaces where all can feel welcome.

Emerging Leader John Michael Graves. (Ryan Berry / The Herald)
John Michael Graves: Champion for diversity and inclusion

Graves leads training sessions on Israel, Jewish history and the Holocaust and identifying antisemitic hate crimes.

Gracelynn Shibayama, the events coordinator at the Edmonds Center for the Arts, is an Emerging Leader. (Olivia Vanni / The Herald)
Gracelynn Shibayama: Connecting people through the arts and culture

The Edmonds Center for the Arts coordinator strives to create a more connected and empathetic community.

Eric Jimenez, a supervisor at Cocoon House, is an Emerging Leader. (Olivia Vanni / The Herald)
Eric Jimenez: Team player and advocate for youth

As an advocate for the Latino community, sharing and preserving its traditions is central to Jimenez’ identity.

Molbak's Garden + Home in Woodinville, Washington closed on Jan. 28 2024. (Photo courtesy of Molbak's)
Molbak’s, former Woodinville garden store, hopes for a comeback

Molbak’s wants to create a “hub” for retailers and community groups at its former Woodinville store. But first it must raise $2.5 million.

DJ Lockwood, a Unit Director at the Arlington Boys & Girls Club, is an Emerging Leader. (Olivia Vanni / The Herald)
DJ Lockwood: Helping the community care for its kids

As director of the Arlington Boys & Girls Club, Lockwood has extended the club’s programs to more locations and more kids.

Alex Tadio, the admissions director at WSU Everett, is an Emerging Leader. (Olivia Vanni / The Herald)
Alex Tadio: A passion for education and equality

As admissions director at WSU Everett, he hopes to give more local students the chance to attend college.

Support local journalism

If you value local news, make a gift now to support the trusted journalism you get in The Daily Herald. Donations processed in this system are not tax deductible.