Share buybacks are not perfect – but are no great evil

US Democratic senators have launched a campaign against share buybacks, arguing they are a significant cause of inequality. Although imperfect, they do have a positive effect.

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  1. Garry White

Former Goldman Sachs’ chief executive Lloyd Blankfein broke a six month hiatus on social media last week to defend share buybacks. This followed a proposal by US Senators Bernie Sanders and Chuck Schumer that would limit a company’s ability to purchase its own equity unless it has met some minimum requirements that benefit workers in the business. Buybacks can be controversial and are not always the best way to allocate capital, but these proposals could be counter-productive for the very people they are trying to help.

The Democrat Senators argue that share buybacks are a major driver of increasing inequality. They say that the richest in society are the main beneficiaries at a time when wages are stagnant for the poor and middle class. Indeed, between 2008 and 2017, 466 of S&P 500 companies spent around $4 trillion on share buybacks, or around 53pc of their profits. An additional 40% of profits were paid out as dividends.

Research from Goldman Sachs indicated that the wealthiest 0.1% of US households hold 17% of privately-held equities and the richest 1% own 50%. This is up from 13% and 39% respectively in the late 1980s. As a result, the Sanders/Schumer proposal wants restrictions on share buybacks until a company has met certain criteria, including paying a minimum wage of $15 an hour, seven days of paid sick leave and decent pensions and healthcare.

The situation regarding buybacks has come to a head following the recent Trump tax giveaway, which also allowed major businesses to repatriate substantial amounts of cash. The President argued the cuts would ensure companies reinvested profits to create jobs and increase wages. However, this did not happen – a huge proportion of the cash was spent buying back equity.

According to data from S&P Dow Jones Indices, stock buybacks by companies in the S&P 500 rose to $720.4bn in the 12 months ended in September 2018, with about $203bn spent in the third quarter of 2018 alone. It is estimated that the figure for the whole of 2018 has breached the $1 trillion level. This compared with buybacks of $519.4bn in 2017 and $536.38bn in 2016.

The fact that buybacks hit a record last year as US markets hit a series of new all-time highs also highlights a major criticism of the practice. It tends to happen not when equity valuations are low but when valuations are particularly high. A 2016 study by McKinsey, somewhat surprisingly, concluded that share buybacks rarely have a lasting effect on total shareholder return – the share price performance plus dividends paid. That’s because most companies do not time these purchases well.

As an example, let’s take a look at BP. Since the year 2000, the oil behemoth has spent slightly more than $62bn on share repurchases. That’s almost half the company’s market capitalisation in dollar terms of $146.4bn. Since the start of 2000, its share price has actually fallen by more than 10pc. A similar situation is seen in US companies such as GE.

Critics of share buybacks also argue that they divert funds from investing in longer-term growth opportunities to provide a short-term sugar rush to a company’s share price. They are also cited this as a method that senior executives can use to flatter a company’s earnings to meet targets for their long-term incentive plans. The latter is often characterised as a corporate misdeed, but the problem there lies with how incentive plans are structured rather than buybacks per se.

In response to the proposals, Mr Blankfein fired off a tweet arguing that the money used for share buybacks didn’t “just vanish”. He said the investor who received money for the repurchased shares will then reinvest the funds in higher-growth businesses that would ultimately boost the economy and jobs. “Is that a bad idea?” Mr Blankfein said. Mr Sanders quipped back that buybacks merely “increased the wealth of billionaires like him”.

This is correct.  The best way to secure long-term prosperity is for cash to be allocated to the growth engines of the economy. These are the areas that, over the long term, will provide jobs and economic security for all. Mature, cash generative businesses returning cash to investors this way provide resources to reinvest in new businesses.

Although there have been net layoff in banks, hiring across the US economy last year was very strong indeed – so much so that every release of jobs data sent a wave of nervousness through the markets on concerns labour market strength would force the Federal Reserve to raise interest rates. Buybacks may have hit a record, but jobs growth is robust too. Investment has also not suffered too – with investment pretty stable for a number of years, according to World Bank date. Also note that the biggest buyback was delivered by iPhone maker Apple, which is hardly a company that can be accused of stifling innovation. It is arguably one of the most innovative companies in the world.

Targeting share buybacks to improve worker conditions is an odd way of achieving these goals. If a minimum wage of $15 is desirable, then pass legislation that directly requires this, rather than doing it tangentially through an attack on buybacks. If they are being used to boost earnings to benefit an executive’s bonus, then change the rules around long-term incentive plans. Buybacks are far from perfect – but they certainly are not the great evil suggested by Mr Sanders.

A version of this article appeared in Friday’s Daily Telegraph.

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