Stock Buybacks Seen as Dubious Investor Benefit
Corporate America is on a share buyback binge, fueling concerns that U.S. companies are masking underlying business problems and trying to pump up their executives' compensation.
While buybacks are generally seen as buoying share prices in the short run, some who have analyzed the trend suggest shareholders would benefit more from dividend increases and note that debtholders can get penalized.
"Management owns options," said Jack Ablin, chief investment officer at Harris Private Bank. "Their compensation rises when the share price rises, not when the dividend increases. This reeks of the excesses of the 1990s."
In the first quarter of 2007, the last for which there is full data, U.S. companies completed a record $117.7 billion in buybacks, according to Standard & Poor's. That was the sixth consecutive quarter of $100 billion-plus buyback announcements and three times the rate of buybacks just three years ago.
Last year, companies on the S&P 500 alone spent a record $432 billion repurchasing their shares -- more than the U.S. government spent on Medicare, the health insurance program for people over 65, according to Howard Silverblatt, a senior equity analyst at Standard & Poor's who tracks repurchases.
The pace has accelerated in 2007. This week, oil company ConocoPhillips said it planned to buy back up to $15 billion of its shares; retailer Home Depot. launched a tender offer for up to $11 billion of its shares; and drugs group Johnson & Johnson said it would repurchase up to $10 billion of its common stock.
Earlier buyback announcements came from retailer Wal-Mart Stores ($15 billion), investment bank Merrill Lynch ($6 billion) and technology group Sun Microsystems ($3 billion). Online travel company Expedia tendered to buy back as much as $3.5 billion in shares.
Silverblatt came into the year predicting there would be $459 billion in buybacks in 2007, up from $432 billion in 2006.
"Obviously," he told Reuters Wednesday, "I'm going to have to raise it pretty soon."
Investors Love 'em
Factors contributing to the surge in buybacks include a buildup of cash on balance sheets after a string of profitable quarters. But slower profit growth also is pushing companies toward buybacks, which lift earnings per share by reducing the number of shares outstanding.
Conventional wisdom says stock investors love buybacks because they lift stock prices or mitigate a slide on bad news. Some researchers like David Ikenberry, finance professor at the University of Illinois at Urbana-Champaign, have suggested that companies that announce buybacks outperform their peers in subsequent years.
Some professionals, from INVESCO, the giant Anglo-U.S. fund management company, to Champaign, Illinois-based Cozad Asset Management, have created funds that only invest in companies that have recently repurchased big blocks of shares.
"There are two ways to increase your share price today," says Silverblatt, "fire a lot of people or announce a buyback."
Buybacks bolster the broader market, reducing the supply of shares at a time when private equity is buying public companies outright and the IPO market is lackluster. But researchers at Penn State dispute the contention that buybacks are good news for investors in individual companies.
They say many buybacks are poorly timed, meaning companies wind up buying their shares at a premium rather than at a discount.
Critics like Ablin prefer dividend increases, which allow shareholders to decide the best use for the money.
While stock repurchases buoy share prices, helping minimize sell-offs, Ablin thinks they are more about rewarding executive insiders than the average shareholder.
He says a "management first" culture prompted the surge in buybacks. In the first quarter of 2007 there were $58.3 billion in dividends paid out versus $117.7 billion in buybacks -- a big change from the first quarter of 2004, when $42 billion in dividend payouts equaled $42 billion in buybacks.
Relatively cheap money -- even with the recent run-up in yields -- also contributes to the purchases, prompting more companies to fund buybacks using debt rather than cash.
Bondholders Angry, Too
That has prompted some bond investors to cry foul.
"They're asking bondholders to finance shareholder-friendly activity," said Joseph Balestrino, fixed-income market strategist at Federated Investors in Pittsburgh. He said the companies involved in buybacks are re-leveraging balance sheets that had been getting cleaner.
"Is it terrible? No," Balestrino said. "Is it a negative trend? Yes."