2020 saw corporations buy back their own stock in record dollar amounts. During Covid’s initial onset and rollout, companies held on to cash because they didn’t know what would happen.
Watch what happens now. The chattering class will be hyperventilating about the use of corporate cash to buy back stock. It should be used for social justice or other things like that.
They are wrong. They are basically uneducated about corporate finance.
That shouldn’t surprise anyone. They are the same people looking to raise taxes on corporations. Corporations do not pay taxes, they aggregate them.
When corporations have excess cash on their balance sheets, they have to get rid of it somehow. Having excess cash on your balance sheet means you become a takeover target. Remember, all the corporations are swimming in the ocean together and competing. They often eat each other.
When one corporation buys another, it uses the target corporation’s cash as a part of the purchase. Most people do not know that nor do they understand the mechanics of how it works. That’s Corporate Finance 101 and I suggest you do a MOOC on it or something to understand it. You won’t find it on blogs.
The Chief Financial Officer (CFO) of the corporation looks at all this excess cash and has to decide what to do with it. Here are their basic options.
Invest it in commercial paper, treasuries, or some other debt instrument in a rainy day fund for when business gets bad or for some potential future investment.
Pay a dividend to shareholders.
Invest in new property, plant, equipment to grow the business.
Raise salaries of employees
Hire more employees
Buy a competitor or another company
Buyback the corporations stock
Usually, the company will do some of or all of the above depending on the amount of cash, the projections and expectations for the future, and the business climate.
If the CFO invests in commercial paper etc, they better really have a good idea where they will deploy the cash down the road. It cannot be a seven year plan because things change too rapidly and having that asset on their balance sheet puts a big target on their back for takeover.
Paying a dividend to shareholders is nice. But, most institutional investors don’t like it because of the tax consequences. Dividends also send a message to competitors that the business is doing well. The IRS ought to change the tax rules on dividends and eliminate them. Then they would be equivalent to a buyback.
Investing in new property, plants, and equipment can be a great idea. There are also meaningful tax consequences here because depreciation can be charged against the earnings of the company. It should make the company more productive and help it grow. However, that investment must leap over any internal hurdle metrics the company sets out for itself. If the math doesn’t work, then the investment is a loser.
Raising the salaries of employees can be a great idea. However, you can never take a raise back. So, it becomes a larger fixed cost to operating the business. Any new employees that you attract will want the same wage. Giving a one-time bonus can be a great incentive, but employees will come to expect it every year. Eventually, they will wonder why they are getting a bonus instead of just higher yearly pay. Labor is the largest fixed cost in business operations.
Hiring more employees is great if you have the capacity and growth. But, it’s expensive to hire and fire. It increases fixed costs, so businesses really do some intense math to figure out if they really need to hire.
Buying competitors can work but there are costs with buying them, integrating them, and making them more efficient. There are also regulatory hurdles that the government puts in place which are expensive to clear.
That leaves buying back stock. It takes cash off the balance sheet. It decreases the amount of float you have in the market. It doesn’t increase the price per share necessarily because the stock market prices in all information, not just the buyback. It does make your earnings per share look better since earnings are divided by fewer shares. EPS is mostly a vanity metric and the market knows it. But, it’s cheap to do. It’s easy to do and to telegraph. Buybacks also send a message to competitors that the business is doing well and you are generating enough cash so they shouldn’t mess with you.
I sort of disagree that buybacks signal to the market that internal executives think the stock is undervalued. I don’t think they are that smart. C-level executives’ decision-making prowess does have the most effect on the stock. But, many executives are also selling stock right now. That’s just telling you they are hedging their bets against a personal tax increase next year.
Bernie Sanders, Elizabeth Warren, and the chattering class won’t have it. They don’t have the first clue of how this stuff works and they also need a whipping boy to institute their socialist vision of the future.
Stock buybacks were DOWN in 2020. Stock buybacks have re-surged in 2021. Doublecheck what the article says as I think it actually says the same thing.
I think buybacks and dividends are both cut from the same cloth -- money to shareholders.
In the case of a dividend -- money to the shareholders who are then taxed at ordinary income rates.
In the case of a buyback -- money to the shareholder who are then taxed at a long term capital gain rate.
There is actually a prohibition as to how much cash a public company can keep on hand. It is limited to cash necessary for changing conditions and some ordinary measure of acquisitions.
Berkshire Hathaway and Warren Buffet have bought back more than $6.5B of their stock in Q2-2021. They bought back $25B in 2020 which was 5.2% of their stock.
It is worth noting that Buffet still owns 16% of BH even after giving away massive amounts of stock, so arguably he is on top of the situation. I like to hear his views on things like this as he has run a public company since the American Revolution.
BH-A is up $343,525 per share to $435,000 currently in 2021, so you could argue that the buyback is paid for by the stock price 1.5X to 2.0X.
Like anything else, there are times that a medicine works and it doesn't work.
An interesting thought point is -- why are CEOs selling so much stock? I think the answer is the goofy notion of taxing appreciated assets.
Keep writing. It is good reading.
JLM
www.themusingsofthebigredcar.com