I’m less enthusiastic about stock buybacks than the editors of the Wall Street Journal are:
Stock buybacks are the latest bipartisan piñata, whacked by politicians on the left and right who misunderstand capital markets. A refresher course is in order lest Congress stampede and undermine the investment needed for growth.
Repurchasing shares is simply one way a company can return cash to owners if it lacks better ideas for investment. Tax reform increased corporate cash flow by cutting tax rates and letting companies repatriate their cash held overseas by paying a one-time tax rate of 15.5%.
Using Federal Reserve data, Dan Clifton of Strategas Research Partners estimates that companies repatriated $730 billion in 2018. CEOs have deployed that for multiple purposes including new investment, debt reduction, pension contributions, employee bonuses, wage and dividend increases and stock repurchases.
This is a policy success. Mr. Clifton calculates that capital expenditures by S&P 500 companies grew about $75 billion in 2018, the fourth-biggest annual gain since 1991. Average wages are growing by at least 3.4% year over year, the fastest rate in a decade.
Maybe it’s just me but I think that stock buybacks are in a different category than other forms of business capital investment. Other forms are ways of making the company more valuable. Stock buybacks do nothing to make the company more valuable. Their intent is, presumably, to make the stock more valuable per remaining share.
If managers can think of nothing to make their companies more valuable, perhaps those companies need better management. It isn’t said enough but among our gravest problems today is bad corporate management. That takes all sorts of forms including being stupid, greedy, lazy, unimaginative, or just lacking in guts. Are all corporate managers bad? No. But too many are. Reforms in corporate governance are long overdue. Our present laws date to the days before so much stock was held by mutual funds, pension funds, and top management.
“Maybe it’s just me but I think that stock buybacks are in a different category than other forms of business capital investment. Other forms are ways of making the company more valuable.â€
The proper terminology for a stock buyback isn’t capital investment, it’s recapitalization. It’s not an investment.
“Stock buybacks do nothing to make the company more valuable.â€
They aren’t intended to. As every first year finance student learns: you cannot change the value of the firm by changing the capital structure.
“Their intent is, presumably, to make the stock more valuable per remaining share.â€
If debt is used, it’s the difference between an unlevered ROE and a leveraged ROE. You forgot to mention the other half of the story. Leverage risk. If internal cash flow is used it’s just a plain vanilla return of capital. Risk adjusted rates of return have been the subject of much academic debate and study. We won’t solve that here.
“If managers can think of nothing to make their companies more valuable, perhaps those companies need better management.â€
It’s situational. There is, and always will be, a spectrum of management talent, and business realities. When I was in business school those sitting in the critics section bemoaned “empire building management†who reinvested shareholder cash instead of paying it back. They made us read and debate articles from editorialists in The NYTs for example. (Snicker), or liberal profs. Chocolate has turned to vanilla. Now they must reinvest say the solons. .
I do know this, having been on boards controlling companies for almost 25 years now. Management teams hardly need an excuse to invest. And the larger a company they grew up in, the more “great†ideas they have to spend money. These snorting, excitable race horses are in their starting stalls like at the Kentucky Derby. It takes sober oversight and controls for that cash to not disappear.
The editors of the WSJ explicitly lump the two together. I can’t judge whether that’s calculated obfuscation or not.
Microsoft, Google, and Apple all have very large cash positions. Why are the “snorting, excitable race horses” holding back?
I don’t know enough about this to have an informed opinion, but I don’t see stock buybacks as inherently bad and it seems much depends on the rationale behind making that choice, which I have no insight on.
I don’t think that stock buybacks are bad, Andy. I don’t think that there is any particular need to encourage them. I would rather see recapitalization and investment treated differently rather than conflated as the editors of the WSJ are doing.
I think that we want and need more capital investment. I am agnostic on whether we need more recapitalization.
“These snorting, excitable race horses are in their starting stalls like at the Kentucky Derby.”
It looks more like they are staked out at the feeding troughs.
Steve
I don’t know why they conflate the two either. But they are fundamentally different concepts. Maybe Microsoft etc know what I’ve been saying – they see no good investment opportunities. How many iPhones with marginal improvements per iteration can you sell? They could pay the cash out, or wait until they do find them. I don’t know their businesses well enough to say.
Steve – nonsense. Enlighten us. Prescribe the investments they should make. Please fully lay out the case and be specific.
Note that, if there are no worthwhile investments to make, you can’t stimulate the economy by cutting business taxes any more than you can by cutting personal income taxes to encourage consumption and/or savings (and the evidence says we can’t).
I think that’s what Lawrence Summers meant by “secular stagnation”.
“be specific.”
Why sure. I will lay out the specifics for every company on the S&P. Shouldn’t take more than 5 or 10 minutes. I will go do that as soon as I finish this post.
Or, we can just look at the income and wealth of the top management class and see that they have benefitted much more than everyone else. There is a major disconnect between growth for the very wealthy and everyone else. You seem to see that as a positive, or else I wouldn’t have to even try to explain this, so go ahead and tell us why it is good that we are making a very small group of people very wealthy and everyone else stagnates. How much do we have feed the horses before everyone else benefits?
“if there are no worthwhile investments to make”
Trump has eliminated all of the bad regulations. He said so. What makes this time in our history, and note that it is a fairly prolonged period, unique in the inability to find stuff to invest in?
Steve
On a more productive note, bigger bonuses for the floor workers and permatemps could improve productivity, either low interest loans or outright grants for them to retrain, kicking in a little extra to the retirement fund, and let the cash make money while they ponder where the company should be in fifty years.
Not really true, Dave. The world, for better or worse, runs on discounted cash flow. (And please people, spare me the trite examples of the very, very rare crazed software guy operating out of his basement.) There is the projected cash flow, a function essentially of demand. And then there are the deductions to that cash flow: production costs, taxes, etc. And then there is the risk, embodied in the denominator. At the end of the day you look at the result. Taxes are no different than any other cost. They matter.
Zerohedge had a recent contributor essay outlining the effects of taxes and investment. Its a large factor.
That’s what I thought, steve. You are just babbling standard talking points.
I wish that was so, Walt. Haven’t seen it. You pay to keep good people because you don’t want to lose them. Bribing them won’t change their work ethic. That’s a character issue.
Let’s recap.
GDP = PC + BI + G + X – I
Personal consumption has grown at trend (around 2.5%) since the tax cut. Federal spending is pretty flat. Exports have grown a little while imports have grown a lot. Savings have been pretty flat so no joy there for future consumption.
For significant GDP growth we need to have more BI. As you point out recapitalization isn’t BI. Where’s the growth going to come from?
“That’s what I thought”
No answers as usual, just magic. Cut taxes and we will have growth. Cut regulations and we will have growth. Do both and we have growth and everyone will be better off, except we have done that and things dont change. All we see is that the management class comes out further ahead.
Steve