Corporate stock buybacks are booming

Corporate stock buybacks are booming, even after Senate Minority Leader Chuck Schumer (D-NY) and Senator Bernie Sanders (I-VT) railed against the practice in a widely circulated op-ed.

According to Bank of America Merrill Lynch (BAML), corporate stock buybacks “picked up to their fourth-largest weekly level” since 2009. They specifically said that activity is pacing 91% above last year’s levels, pointing to another record year. To put that in context, 2018 was a record with U.S. companies putting more than $1 trillion toward stock buybacks.

“Buybacks remain strong in Tech and Financials, but have broadened out across other sectors YTD: notably, Staples and Materials buybacks are on track to handily exceed 2018 levels. The current pace of buybacks would suggest a record year in these two sectors plus Financials and Utilities; Industrials and Discretionary buybacks, while below post -2009 records, are also set to eclipse last year’s levels,” the BAML report said.

Source: Bank of America Merrill Lynch
Source: Bank of America Merrill Lynch

Buybacks have come into focus after Schumer and Sanders introduced legislation this month that aims to prevent company stock buybacks unless the firms put employees first, including a $15 minimum wage, seven days of paid sick time off, and health and pension benefits.

In their op-ed, the pair slammed the $1 trillion worth of stock buybacks in 2018 as a "practice of corporate self-indulgence."

The reason it's problematic, they argue, is that buybacks don't benefit most Americans because a small percentage of people own a majority of the stocks. What's more, many executives receive stock-based compensation and would benefit from share repurchases. They also argue that buybacks limit a company's ability to invest in wages, R&D, training, and other benefits.

Debt-financed buybacks make for a riskier corporate economy

Bond king Jeffrey Gundlach, the founder of DoubleLine Capital, which oversees $121 billion in assets, told Yahoo Finance last week that legislators telling companies what to do with their profits is "a little bit disconcerting" and legislation prohibiting or limiting buybacks would be a negative for the stock market. Put another way, buybacks have been one of the engines of stock price appreciation.

Gundlach has warned of the elevated levels of corporate leverage, which have come as a direct result of companies using debt to finance stock buybacks.

"It's pretty clear that the leverage ratios in the corporate bond market ... have been hand in glove with buybacks and the corporate economy is very leveraged," Gundlach said.

Gundlach believes the thought process of the politicians supporting curbing buybacks is to stop enriching the wealthy by boosting stock prices.

"But, the politicians are clearly talking about socialism, democratic socialism. Just put the word democratic in front of the word socialism because it sounds good."

It's not just liberals going after share repurchases. Even Senator Marco Rubio (R-FL) has criticized companies that buy back stock instead of reinvesting in the business. He proposes taxing buybacks the same as dividends.

"I mean, it is interesting that a Republican is proposing legislation to curb buybacks. That shows you that Marco Rubio wants to get in front of this issue before somebody on the other party claims it as their own. So the support for limiting buybacks seems pretty high," Gundlach said later in the conversation.

Many prominent voices have weighed in on the debate.

Former Goldman Sachs CEO Lloyd Blankfein took to Twitter earlier this month for the first time since leaving his post at the bank to respond to the senators' criticism.

To that, Senator Sanders fired back.

A day later Blankfein responded.

Stock buybacks have been controversial for a long time.

Warren Buffett makes the case for buybacks

In Berkshire Hathaway's 2016 annual letter, Warren Buffett wrote that discussions around buybacks have "often become heated." He made a case that buybacks only make sense for long-term shareholders if "the shares are bought at a price below intrinsic value.”

"As the subject of repurchases has come to a boil, some people have come close to calling them un-American — characterizing them as corporate misdeeds that divert funds needed for productive endeavors. That simply isn’t the case: Both American corporations and private investors are today awash in funds looking to be sensibly deployed. I’m not aware of any enticing project that in recent years has died for lack of capital," Buffett wrote at the time.

Buffett also wrote that there are two instances when buybacks shouldn't take place. First, if the company needs capital for long-term investments in its business and doesn't want to add more debt. And second, if the company needs the money for an acquisition or another investment opportunity that would offer "far greater value than do the undervalued shares of the potential repurchaser."

Buffett’s right-hand man, Charlie Munger, the vice chairman of Berkshire Hathaway, weighed in on the controversial matter of stock buybacks and presidential candidates proposing tight restrictions on Thursday from the Daily Journal’s (DJCO) annual meeting in Los Angeles.

"Generally speaking, I'm restrained in my enthusiasm for politicians telling corporations what they should do,” Munger said in response to a question about buybacks from Yahoo Finance.

"But, I will say this — when it was a very good idea for companies to buy back their stock, they didn't do very much. And the stocks got so high priced it's created a bad idea. They're doing it a lot. Welcome to adult life. This is the way it is," Munger said. "But, it's questionable at present levels whether a lot of it is smart."

During his reply, he singled out hedge fund manager Eddie Lampert and Sears (SHLDQ).

"Is Eddie Lampert smart to buy back so much Sears Roebuck? No. And a lot of those that allowed that kind of mistake that's been made."

In a recent client memo, noted investor Howard Marks, the founder of Oaktree Capital Management, took issue with the idea of the government telling companies how they should be run.

"I absolutely am not writing to defend stock buybacks or criticize labor representation on boards. What I oppose is (a) the idea of governments deciding how companies will be run and (b) the appropriation of corporations' economics for parties other than their owners."

Marks continued: "What would be the effects of turning over some of businesses’ capital to workers, or requiring that they be put on corporate boards? Clearly, to do the former would be comparable to saying to shareholders, 'That thing you thought you owned — the company — you don’t really own that.' Stock buybacks are a way of returning capital to companies’ owners. Why should each one be accompanied by giving an equivalent amount to workers? Wouldn’t the next step be to say, 'Whenever a company pays a dividend, it has to distribute an equal amount to its workers’? And wouldn’t that be tantamount to saying, 'As for corporate capital, the workers own half'? Consequences? Ask yourself who would start a corporation in the future if it meant the workers would be entitled to half the gains."

And so the debate goes on.

Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.