Record buybacks imperiled by 1% excise tax and weaker CEO confidence in economic outlook

Published Fri, Sep 9 202210:09 AM EDTUpdated Fri, Sep 9 202210:15 AM EDT

The new 1% tax on buybacks is attracting Wall Street attention. That's because in recent years, buybacks have competed with dividends as the top means by which corporate America returns cash to shareholders. It's also the way companies can improve their earnings per share. Companies that buy back their stock also reduce their share count, improving their earnings per share, since there are fewer shares outstanding. This is not a trivial issue. A record level of buybacks occurred in 2021, and 2022 started strong as well. The first quarter saw a record for quarterly buybacks. The second quarter was down almost 20% due to fewer buybacks from financials, but was still strong. S & P 500 Buybacks Q3 2021: $235 billion Q4 2021: $270 billion Q1 2022: $281 billion (quarterly record) Q2: 2022: $226 billion (est.) Source: S & P Global Bottom line: the 12 months ending June 2022 saw $1.012 trillion in stock bought back, the first time buybacks topped one trillion, according to S & P Global. That is significant: in the 12 months ending in June, S & P estimated that 21.3% of the companies in the S & P 500 increased their earnings-per-share by at least 4% thanks to their newly lowered share count. Technology companies who buy back their stock will be getting some larger tax bills, according to an analysis by S & P Global. The Inflation Reduction Act of 2022, signed into law on August 16, contains a new 1% excise tax on the net corporate repurchase of corporate stock, effective for taxable years beginning after December 31, 2022. "On a proforma basis, based on the 2021 buybacks and issuance, the impact on S & P 500 earnings would have been to reduce operating earnings by 0.48%," writes Howard Silverblatt, S & P's Senior Index Analyst. The Technology sector would see the biggest impact, with Apple paying an additional $877 million in taxes, followed by Alphabet ($503 million extra), Meta Platforms ($501 million) and Microsoft ($275 million). Berkshire Hathaway rounds out the top five, at $271 million extra. Will this slow down the strong pace of buybacks we have seen in 2022? It's unlikely. "Going from zero to anything is the biggest increase, so while the 1% tax is an additional cost, I do not see it as significant enough to impact buybacks," Silverblatt said, although he conceded some 2023 buying may be moved into the fourth quarter of 2022. That effect has been noted by others, including Christine Short at Wall Street Horizon. "It's quite possible that the next several weeks could feature unanticipated buyback program initiations among U.S. companies seeking to pull-forward share repurchases before next year's 1% tax hits," she wrote in a recent note to clients. "We already might be seeing this — Bank of America Global Research reports that its corporate clients bought back stock at the highest rate since January in the week after the bill went into effect. While a 1% tax is not much, some argue it could open the door to heftier tax rates down the line." Another wild card for buybacks: the extent of the economic slowdown the rest of the year. Weaker CEO confidence in the economic outlook may cause a slowdown in buybacks.