Are we seeing a buyback backlash?
At some point in the latest phase of the half-decade-long corporate stock-buyback binge, general opinion of the practice turned from approval to exasperation. The strain of commentary toward heavy stock repurchasers has gone from, “Well, at least they won’t do much harm,” to “Stop eating yourselves alive and do something to feed the rest of the world.”
The official line on share repurchases from companies was always that it represented a prudent use of excess cash — a tax-sensitive way of returning capital to those investors who wished to sell, while avoiding risky or unprofitable new spending projects. When economic growth is tepid and lending rates are low, the math of using cash on hand or borrowing at, say, 3% to produce effortless per-share earnings growth in excess of the debt cost can look like a no-brainer.
In the early 2000s and again in the years right after the Great Recession, this fit with the general view of investors — even if some always grumbled that this steady absorption of shares was cosmetically goosing per-share earnings and “artificially” supporting stock prices.
As the economic cycle and bull market have matured, the dependence of many companies on heavy share buybacks — often funded through lots of debt — is increasingly being assailed as sapping needed capital investment, padding executive compensation and possibly destroying capital by overpaying for their own equity.
In reporting a slight dip in total buyback volume in the second quarter, FactSet Research noted that, even with the 1.1% 12-month decline, buybacks consumed 82% of Standard & Poor’s 500 companies’ free cash flow, up from 25% in 2010.
Meantime, as noted here, corporate insiders have been buying less of their own stock (apparently finding it a less attractive use of their own money), and capital investments as a percentage of profits and revenues remain stalled at subpar levels.
A recent Harvard Business Review article boiled all this down to a determination that companies are exacerbating income and wealth inequality through buyback-centric policies that direct cash to the shareholder class rather than into productive, job-generating efforts.
And I’ve looked recently at how big companies’ rigid and punitively high requirements for calculating how profitable a new investment must be before green-lighting it feeds the impulse to buy back stock as a default decision.
Best option for some
Yet for certain types of companies, it’s hard to see an easy way off the buyback treadmill, and repurchases might remain the best option among several not-so-great ones.
The first group includes the enviable “cup runneth over” category – highly profitable, nicely growing or dominant businesses that have so much cash they don’t need to maintain their advantage and can hand lots of it back to investors.
Apple Inc. (AAPL) is in this group, using and borrowing against its towering $100 billion-plus cash pile to bid for its shares as a means of making its balance sheet less inefficient. There’s nothing smart that can be done with $130 billion in cash, so the market will never give full credit for its existence. Cutting into it to buy in stock makes sense and gives remaining shareholders greater leverage to Apple’s operating results.
Then there are the post-growth blue chips who need to substitute financial shuffling for true profit progress. Consider International Business Machines Inc. (IBM), an aggressive buyback player for years. Its business is quite mature, and it has been selling or shrinking capital-intensive divisions. Investors don’t want to see Big Blue placing big-money bets on expanding its own capacity or buying into brand-new businesses.
The company repurchased an average of $14 billion in shares annually from 2010 through 2013, materially shrinking its supply of stock. Over that span, its net income grew only 4% in total (not per year – in total), yet earnings per share in 2013 were 14.4% above 2010 levels.
It’s no surprise tech is the leading buyback sector. Not only do younger companies need to offset the dilution from over-generous stock-compensation awards, but Old Tech is cash rich and growth starved.
Or how about Bed Bath & Beyond Inc. (BBBY)? The one-time “category killer” in housewares is now struggling to resume growing under pressure from online retailers. The company has so intently sought to consume itself progressively in the open market that some on Twitter have called it Bed Bath & Buyback.
The company, which now has a $12.5 billion market value, has repurchased an average of $1.1 billion in shares over the past three fiscal years. In that time, net income has been virtually flat, inching up 3.3% from $990 million in fiscal 2012 to $1.02 billion in fiscal 2014. Per-share earnings, meantime, spurted 18% from $4.06 to $4.79. That’s a nifty trick, though finance scholars and corporate governance types would likely say the cash would be better used initiating and then increasing a dividend over time rather than relying solely on buybacks.
Bed Bath & Beyond shares popped higher by 7% Wednesday on slightly better-than-expected per-share results, augmented by a debt-enabled buyback once again. The company may be further spurred toward buybacks by chatter of an activist investor possibly taking a stake or buyout firms sniffing around the company.
Yet it’s noteworthy that Bed Bath and IBM share prices have been pronounced laggards. Both are essentially flat over the past two and a half years, while the S&P 500 has climbed more than 40%. With their buybacks, these mature companies have essentially fought the sellers to a stalemate but have gained little lasting advantage.
The market’s stance on the buyback theme has seemingly shifted in recent months. Big repurchasers have vastly outperformed the broad market during this bull market, but at the start of 2014 such stocks stopped leading.
The PowerShares Buyback Achievers Portfolio (PKW), for instance, is up more than 140% the past five years compared to just less than 100% for the S&P 500. But year to date, the buyback ETF is up only two-thirds as much as the S&P 500.
Another buyback-focused ETF, AdvisorShares TrimTabs Float Shrink ETF (TTFS), which applies some growth filters and only buys companies that are actively reducing their share count, has done better than the PKW fund, but it too began to lag the market slightly six months ago.
So perhaps buybacks will no longer appear as attractive or as obvious a choice for how companies deploy capital as it’s been since 2010 – even if some aging companies will be left with few attractive alternatives.