Last year, American politicians like Bernie Sanders and Chuck Schumer introduced a plan to restrict stock buybacks. This is a big step as politicians try to dictate to American businesses what to do and how to use their excess cash. Buybacks have been a big success for corporate executives and shareholders. According to Bloomberg Intelligence, companies that have actively bought back their stocks have outperformed the rest since 2009.
A buyback is when a company purchases back its own shares from its investors, reducing its outstanding share count and boosting its Earning Per Share (EPS). While investors get a higher return on invested capital, corporates benefit from increasing stock prices as a growing EPS makes them shine on quarterly earning calls. But, is it a good use of cash?
Some people have argued that a company can use this cash in a much more efficient way in the form of acquisitions, wage increase, research and development, capital expenditures, etc. This is exactly why U.S. politicians are trying to force companies to invest back into the economy in order to boost economic growth. In 2016, President Trump even tried to boost business spending by reducing the effective corporate tax rate to 22%. But there was hardly any impact on the same.
These buybacks are done mostly by companies sitting on the biggest piles of cash. For 3rd quarter 2019, Apple (NASDAQ: AAPL) led the group with a massive $68,557 million worth of shares bought back, followed by Oracle (NYSE: ORCL), Wells Fargo (NYSE: WFC), JP Morgan (NYSE: JPM), Microsoft (NASDAQ: MSFT), Alphabet (NASDAQ: GOOGL) and Bank Of America (NYSE: BAC). Overall, the group is dominated by Technology & Financial stocks.
In the fourth quarter of 2018, American companies spent a record of $223 billion in buybacks and $189 billion for Q4 2019. The more troubling part is where companies are taking on more debt to fund these buybacks, which is in turn fueled by lower interest rates. Rating agencies have started downgrading bonds of companies like Oracle who are financing buybacks using leverage. These factors create an overall scenario where U.S. corporations have higher debt on their balance sheets and are consistently making fewer business investments and contributing less to the overall wage growth of the economy. This has a significant impact on the U.S. economy and is exactly what U.S. politicians are trying to stop.
But, take a step back to understand this from the company’s perspective. Maybe corporate leaders are pessimistic about future demand and economic growth and they don’t see attractive investment opportunities for their company where they can get an attractive return on their investment. In this case, they choose to return their money to the shareholders, who can make better use of their money by investing in more profitable ventures.
One thing is clear, buybacks are a big part of the U.S. economy and financial markets and there is no sign that that’s about to change.
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Contributing Writer at MyWallSt
Shivam’s favorite stock is Xilinx because he believes that it brings something groundbreaking to the very competitive semiconductor industry.