How a Potential End to the Stock Buyback Boom Could Affect Your Portfolio

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After U.S. companies spent more than $1 trillion repurchasing shares last year, the debate over stock buybacks has quickly re-entered the spotlight. This strategy has long been a divisive topic among the investing public; critics argue that buybacks overly reward executives and mask internal corporate problems, while supporters believe they effectively return money to shareholders.

Despite varying opinions, there’s no question that firms are hungrier than ever for their own shares. This snowballing trend reignited the political debate earlier this week, leaving investors wondering if 2019 will mark the end of the decade-long buyback boom.

Let’s analyze this week’s news and how it could end up influencing corporate policy – and by extension, your portfolio – this year…

The News

The latest round in the buyback fight kicked off on Feb. 3 when Chuck Schumer and Bernie Sanders co-authored a fusillade in the form of a New York Times opinion piece. The Democratic senators pulled no punches, denigrating the lack of value buybacks have for American workers and scolding the way companies have weaponized them to create the “worst level of income inequality in decades.”

Schumer and Sanders further criticized the ways buybacks strictly benefit the top 1% of Americans, as the majority of citizens aren’t large shareholders that stand to benefit the most from a buyback’s effect on stock prices. This, the senators argued, feeds money “overwhelmingly to shareholders and executives, not workers.” The article also asserted that not only do buybacks widen the wealth gap, but they also divert cash away from more productive avenues, such as R&D, wage growth, and better benefits for workers.

After outlining the negative effects, the senators announced they plan to introduce a bill prohibiting companies from implementing buyback programs unless they first take measures to invest capital in their workers. It would essentially “set minimum requirements for corporate investment in workers and the long-term strength of the company as a precondition for a corporation entering into a share buyback plan.”

The piece drew varied reactions from high-profile lawmakers and Wall Street vets, but none was more prominent than the Twitter response from Lloyd Blankfein. On Feb. 5, the former Goldman Sachs Group Inc. (GS) CEO challenged the senators’ claim that share repurchases don’t have a positive effect on the broader economy, tweeting: “The money doesn’t vanish, it gets reinvested in higher growth businesses that boost the economy and jobs. Is that bad?”

The Numbers

While 2018 may be considered the year of “Peak Buyback,” a closer look indicates that the trend has reached record levels nearly every single year since the Great Recession.

As the opinion piece mentions, publicly traded U.S. companies spent a whopping $4 trillion on share buybacks from 2008 to 2017. For some context, $4 trillion inches near the annual gross domestic product (GDP) of Japan. For even more context, last year’s $1 trillion on buybacks exceeded the annual GDP of 166 countries.

Some of the most high-profile buyback programs in recent years came from massive companies that are flushed with cash yet aren’t too eager to reinvest in certain areas of their business. Apple Inc. (AAPL), which hoards a mammoth cash pile exceeding $280 billion, announced an earth-shattering $100 billion buyback plan early last year, culminating in a total of $239 billion spent on repurchases in the last decade.

While it’s true that buybacks almost always lift stock prices in the short term, investor sentiment can sometimes derail these knee-jerk rallies. This was the case with Walmart Inc. (WMT) on Oct. 14, 2015 when its shares nosedived 10% after announcing a $20 billion buyback program. However, Walmart constituted a very unique case that strayed from typical market behavior around buybacks, which is, for the most part, exceedingly bullish.

The Bigger Picture

It’s unsurprising from a fundamental perspective that buybacks benefit large shareholders the most. It’s even more unsurprising that the largest shareholders happen to be that company’s upper-level executives.

These facts lay the foundation underneath the negative perception of buybacks that dominates left-wing economic thought. Company leaders who own millions of shares of their company wield the power to exponentially increase their wealth (and widen the overall wealth gap) by instituting buyback programs. This, of course, allows them to fatten their bank accounts seemingly whenever they want, while simultaneously promoting an “everybody wins” mentality by deepening the shareholders’ pockets, albeit by much less.

Critics also frequently accuse stock buybacks as a way to juke quarterly numbers or commit a form of “financial engineering.” The reasoning here stems from the fact that buying back more shares can boost the important earnings metrics, such as earnings per share (EPS), that investors rely on to judge a firm’s financial strength. By repurchasing shares, a company decreases the number of outstanding shares and therefore increases its EPS simply by manipulating supply and demand. Earnings increase without any effort from the company to strengthen revenue streams or do anything that would boost the business’s profitability.

For example, let’s say Company Z earns $5 million a year and has 400,000 outstanding shares, resulting in an EPS of $12.50. If Company Z buys back 100,000 of those outstanding shares, the EPS jumps to $16.67, despite the company not actually increasing its profit or revenue. Any investor using EPS as a way to gauge the company would be misled since, in reality, the company’s profit is far below what its EPS reflects.

Whatever the case, people can certainly shoot holes in both Blankfein’s and the senators’ arguments. Investors dump money into companies with the goal of growing that original investment via share-price growth and dividends. Some individual investors may not have an opinion one way or the other on how those firms make them money. On the other hand, some investors motivated by honest corporate practices may shake a stick at buyback strategies, even while their portfolios get greener in the process.

Looking Ahead

Whether or not lawmakers actually push a bill through Congress this year remains to be seen. With immigration and infrastructure front and center among many other issues in Washington, it’s doubtful that Democratic lawmakers will be able to spar with anti-regulation Republicans enough to move a financial measure such as this up on the list of priorities anytime soon.

That being said, the buyback boom will likely continue through 2019 until Congress resurfaces the issue with legitimate legal action. Given the highly volatile market environment following a brutal 2018, America’s largest companies may try to prop up sentiment (and the indexes) by repurchasing more shares. Either way, investors can at least try to look forward to the generous stock rallies that come along with such a divisive corporate tactic. 

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