During the 12 months ended June 30, Companies in the S&P 500 index spent $1 trillion to buy back their own shares, according to S&P Dow Jones Indices. But in January, a new 1% tax on repurchases could reduce the appetite of American companies. S&P Dow Jones estimates that the tax will reduce profits by half a million percent at current purchase prices.
Buybacks have become a hot topic lately, with critics saying there are better uses for the company’s cash. But a 2020 S&P Dow Jones Index analysis of the 100 companies with the most buybacks found that their long-term returns outperformed the S&P 500.
Many smart investors, including Warren Buffett, are big proponents of strategic buying. “If a manager wants to strengthen our assets by buying shares, we applaud,” he said.
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The new tax is so low that it will discourage only the smallest purchases, experts say, so don’t expect it to disappear. But evaluating repurchases can be tricky. For investors trying to navigate this volatile market, there are a few indicators that can help you find stocks that could benefit from repurchases despite the tax. But the basics first.
The pro. Buybacks make a lot of sense when a company can dump shares whose price has been unfairly pushed below fair value due to market fluctuations. Such purchases reveal the faith of the insiders in the company and add to the demand that supports the stock price.
Many investors prefer repurchases over dividends because even though you have to pay taxes on dividends when you withdraw them, you don’t pay capital gains taxes unless you sell your shares. In addition, when the company buys more shares than it issues, the remaining shares represent a larger share of the company.
Some investors want companies to distribute cash through buybacks so managers aren’t tempted to make worse choices, said Meb Faber, chief investment officer at Cambria Investment Management. “How many companies have spent money on stadium naming?”
Executives like buybacks because by reducing the number of shares outstanding, a company can report higher monthly earnings even if overall profits are down or down. This can be a very attractive strategy for any executive whose compensation is tied to an increase in earnings per share.
Repurchases satisfy managers. A company that raises its dividend could see its stock plummet if problems later force it to cut dividends. But buyback programs can often be stopped without impressing investors. Another benefit: Every share taken home means smaller payments to companies that pay dividends, reducing future cash obligations.
Finally, economists like buybacks because they take money from companies that don’t have good internal investment ideas and return it to shareholders—who typically reinvest it in other companies. publicly (which, presumably, has a more productive investment plan).
| YEAR- | Share Buybacks (billion) | Dividends (billion) |
|---|---|---|
| 2022 (until June 30) | $501 | $278 |
| 2021 | 882 | 511 |
| 2020 | 520 | 483 |
| 2019 | 729 | 485 |
| 2018 | 806 | 456 |
The cons. Politicians as diverse as Sens. Elizabeth Warren (D-Mass.) and Marco Rubio (R-Fla.) have tried to discourage buybacks. Critics hope it will prompt companies to invest more in their operations, creating new jobs.
Although some studies highlight the positive aspects of buybacks, others conclude that shareholders often make more money using other funds. Greg Milano, CEO of Fortuna Advisors, an investment advisory firm, said Fortuna has seen over the past 12 years that, on average, companies that have increased earnings per share because of the investment in the work has resulted in double the profit of the company which raised the percentage. share profits through repurchases. Dividend payments have led to higher returns than buybacks.
And Milano cautions that despite the upside, many buybacks don’t give investors a bigger stake in a company because companies often issue more shares in compensation plans. based on stock due to its purchase. At worst, investors have been burned by companies that have spent billions instead of cleaning up their balance sheets or investing in their businesses to protect against recession — as some airlines have recently done. , for example. (For more information on airlines, see Why are airline stocks a bad deal?)
How to pay. Investors who still want to ride the coattails of buyback programs should follow three rules, experts say. The stock mentioned below provides a good example.
Avoid dilution. Don’t jump at every purchase announcement. Check to see if the number of companies in general is decreasing, thereby increasing your share of the company, says Faber. You can look up a company’s outstanding shares on the Securities and Exchange, or you can find the latest numbers on sites like Yahoo Finance and YCharts. A good example is this McKesson (MCK (opens in a new tab)), says Faber, who owns an investment company. Pharmaceuticals and drug distributors have reduced their inventory by 7% in the past year, and their stock prices have doubled in the past five years.
Find the cost principle. Successful buyers, like successful investors, should buy low. Buffett’s Berkshire Hathaway (BRK.B (opens in a new tab)), sitting on more than $100 billion in cash, buys back its own shares when prices fall below what Buffett calls “intrinsic value.” Morningstar sector analyst Greggory Warren noted that the company has bought back $58 billion in common stock since 2019, reducing its share count by 10%. Warren, the Berkshire bull, believes that the company is focused on reducing long-term debt accumulation through a mix of stock buybacks and buybacks.
Betting on healthy companies. Fortuna’s Milano said that companies that can have long-term returns on their acquisitions have strong balance sheets and, ideally, are less vulnerable than other companies to economic cycles or the goods. A company high on his list: apple (AAPL (opens in a new tab)). Until the beginning of 2021, Apple bought more than 200 billion dollars in stock, reducing the number of its shares by 5%. In that time, the stock has gained about 6%, excluding dividends, compared to a 3% loss for the S&P 500 index. of S&P Dow Jones Indices, “Apple is the poster child for buybacks.”
