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Apr 16, 2018

What’s a Stock Buyback?

By Stash Team

Why are so many big companies are buying back their own stock? We explain it.

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When President Trump and the Republicans signed their massive tax-cut bill in December, they argued that it would lead to increased levels of investment, new rounds of hiring, and wage increases for the nation’s workforce.

The centerpiece of the bill was a permanent reduction of the corporate tax rate, dropping the top rate to 21% from 35%. Congressional lawmakers assumed this money — previously destined for government coffers–would provide U.S. businesses with more cash to hire workers and dole out raises.

Corporate America, however, hasn’t capitulated to the degree that Republicans had hoped. While some U.S. workers have benefitted from well-publicized bonuses, many companies are using their tax savings to consolidate their ownership.

Or, in other words, they’re engaging in stock buybacks.

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What’s a stock buyback?

A stock buyback is exactly what it sounds like.

Also called a stock repurchase, it’s when a public company buys its own shares on the stock market. It’s a company re-acquiring itself, so to speak.

It’s like that scene in Terminator 2, where the movie’s villain, the T-1000, is blown to bits by Arnold Schwarzenegger. Though it’s in pieces, it’s able to reconstitute itself.

You can think of a stock buyback in similar terms.

A company’s ownership is spread throughout the economy. But it can reconstitute itself through a buyback. With some extra cash, via tax savings, a company can consolidate through stock purchases.

Why do companies buy their own stock?

The short answer is to increase value for its shareholders.

A company buying its own shares on the open market decreases the overall number of shares. As a company reabsorbs its shares, the remaining shares can become more valuable, because there are fewer of them. The individual stake of shareholders also increases, and often, the price of their shares.

Raising the price of shares is, often, the goal of a stock buyback. Though it doesn’t always improve the price.

While dividend payments are the traditional vehicle used to return value to shareholders, stock buybacks have become an increasingly popular reward tactic for companies around the world.

This February, for example, U.S. corporations announced more than $150 billion in buybacks, according to industry analysts.

The effects of buybacks

Though they’ve been common for decades now, buybacks are often criticized for being a cheap way to manipulate the markets. And given that huge tax cuts were levied along with hopes of corporations letting the money “trickle down”, corporate buybacks are being scrutinized harder than ever.

Opponents of buybacks, like Senator Elizabeth Warren, say that buybacks do little to help the economy, while giving the illusion of performance for companies.

“Stock buybacks create a sugar high for the corporations. It boosts prices in the short run, but the real way to boost the value of a corporation is to invest in the future, and they are not doing that,” Warren told The Boston Globe.

Many corporations are spending more on share repurchases than they are on research, development, and hiring, a Reuters investigation recently found.

And the issue, on a larger scale, is that these buybacks don’t translate to increased hiring or wage growth, which was what justified the recent tax cut bill.

Should investors consider cheering on stock buybacks?

As an investor, a buyback can be a good thing. It may, after all, lead to an increase in the value of your holdings. But you have to consider what’s happening beneath the surface.

Should you be happy that your holdings are worth more, or worry that a company’s executive team is giving you a “sugar high” at the expense of long-term value creation?

It’s hard to tell. And with corporate share repurchasing at near record levels, a certain level of skepticism is warranted before getting too excited about an incremental jump in the value of your portfolio.

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