What investors should know about buybacks, including these top 'buyback monsters'

Published Fri, Feb 11 20227:40 AM ESTUpdated Tue, Apr 5 202210:10 AM EDT

Good news for investors: There are oceans of money flooding into the coffers of corporate America. "Corporate America is flush with cash, and they don't know what to do with it other than return it to shareholders as buybacks or dividends," Ben Silverman, director of research at VerityData, told me. First, it was dividend payouts reaching a new record. Now, it is buybacks. Executed corporate buybacks for the fourth quarter of 2021 are now estimated at $265 billion. For the full year, buybacks are at $876 billion, a new record that easily tops the prior record of $806 billion in 2018, according to S & P Dow Jones Indices. Buybacks 2018 $806 b. (prior record) 2019 $728 b. 2020 $520 b. 2021 $876 b. (record) Source: S & P Dow Jones Indices In the last several weeks, large buybacks have been announced by Twitter , DuPont de Nemours , Hanesbrands , Penn National Gaming , Ralph Lauren , PulteGroup , ExxonMobil , and HCA Healthcare . The Meta disaster: buying back stock at the wrong time But an old problem has emerged once more: Corporate America bought back massive amounts of stock in the fourth quarter, only to see a good part of it evaporate in the big drop in January. Take Facebook's parent company Meta , which has dropped almost 30% since its disastrous earnings report , but the company spent roughly $20 billion on share buybacks in the fourth quarter, at a time when it was trading between $310 and $350. It closed at $228.07 on Thursday, which means the company spent a huge amount of money buying stock just before an enormous price drop. How much do stock buybacks help prices? It's been an open secret for years. While many companies announce buybacks, many also keep up aggressive distribution of options to executives, which serves to simply rotate out old shares being bought back with new ones that are being exercised by corporate executives. The result: For many companies, buybacks do not result in a reduction in share count, which is what matters, because reduced share count is what improves earnings per share. The shares outstanding in the S & P 500 are slightly higher compared to 2018, even after nearly $3 trillion in buybacks were executed. S & P 500: shares outstanding 2018 300 billion 2019 296 billion 2020 312 billion 2021 306 billion Source: S & P Dow Jones Indices Another issue: With markets hitting record levels last quarter, more employee stock options came in the money, driving up share count. No wonder Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America, recently complained: "[T]he relationship between S & P 500 buybacks and index performance since 1986 is … minimal," she said. Buybacks continue despite ever-higher prices The Meta debacle highlights a major problem for companies that seem to be indifferent to when they are buying stock. It's been a problem for years, and even Warren Buffett has complained about it. Part of the problem is that in recent years the overall market has been rising, so companies are repurchasing their shares at ever-higher prices. This has two effects: It reduces the amount of shares that can be bought back, and it tends to make companies insensitive to when they are buying back stock. Obviously, strategically buying back stock at lower valuations is a superior tactic. The recent drop in the overall market may be helpful for stock buybacks, as Subramanian notes: "What we can validate is that companies that repurchase shares at inexpensive valuations tend to outperform." With prices down, have companies been aggressively buying back their stock? Silverman is not optimistic. "Corporate America doesn't have a great track record of buying back stock opportunistically," he told me. "We had a pullback, and corporations hoarded stock, when they had a chance to buy it cheap, but they didn't." Buyback monsters: Some companies really are reducing share count through buybacks While buybacks have become newly popular, historically most of them have been done by banks and technology companies. While some banks have been aggressively buying back stock and reducing share count (Citigroup, Zions, Comerica, Bank of America, Wells Fargo and Regions Financial have all reduced share counts 20% or more in the last five years) the bulk of the buyback spending has been done by technology companies. Why? They are the companies that have the largest cash flows, which enables them to buy back stock. Not surprisingly they are the companies that have most succeeded in reducing their share counts, often by wide margins. Buyback monsters (share count reduction, last 5 years) Oracle (ORCL) 35% HP (HP) 34% Seagate (STX) 24% Qualcomm (QCOM) 23% Apple (AAPL) 22% NXP Semiconductors (NXPI) 22% Source: S & P Global This means that all other metrics being equal, Oracle – for instance – has improved its earnings per share by 35% in the last five years just by the magic of share-count reduction. This is completely independent of whether it has improved revenues, or any other metric of profitability. No wonder some critics call it "financial engineering." The enormous sums spent on buybacks has fueled outrage in Washington, where many have long complained that buybacks do little but enrich management. President Joe Biden's Build Back Better plan had a proposal for a 1% excise tax on buybacks . The Securities and Exchange Commission is considering a proposed rule to "modernize" disclosure of share repurchases by corporations. "Buying back stock helps one class of people [executives and some shareholders who see share count reduction], but it doesn't help other classes, like workers who don't own stock," Silverman told me. Which is more important: dividends, buybacks or investing in the company? Companies have several ways they can distribute their cash flow. They can keep the money, buy back stock, pay down debt, make capital expenditures, or pay a dividend. Dividends and buybacks have dominated corporate cash flow for years. Will the tide ever turn? Will there suddenly be more interest in investing in new businesses and opportunities, and less interest in just returning cash to shareholders? Silverman understands the frustrations of those outside the "buyback/dividend loop." "I think people are started to talk more about growing business, increasing market share, and doing things better, rather than just financial engineering," he said. "I think this is especially true if the economy slows, to start asking is this (buying back stock) really the best use of our cash?" While the conversation around buybacks and dividends has become more robust, don't hold your breath waiting for a big change from corporate America. "Executives get rewarded for returning money to investors," Silverman told me. "It is rare to criticize companies for buying back stock."

Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., December 9, 2021.

Brendan McDermid | Reuters

Good news for investors: There are oceans of money flooding into the coffers of corporate America.