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Are stock buybacks evil?

Our answer:

Companies reward their investors by giving them a share of the profits - paying dividends or buying back stock. With these shareholder rewards reaching record highs amidst rising layoffs and widening income inequality, dividends and buybacks have come under fire. These investor reward mechanisms are necessary for a functioning market, but in the face of slowing growth, every company may need to reevaluate its priorities.

How do companies reward shareholders?

Companies with extra cash can reward shareholders for their support in two ways. First, they can distribute money directly to investors, literally giving them a share of the profits by paying them a dividend. Companies will declare that every investor gets $X for each share they own. If you own a share of that stock in your investment account, you'll receive a cash deposit every three months.

Second, companies can repurchase their own shares from public investors. Buybacks allow companies to reduce the number of outstanding shares in the market, making each remaining share more valuable. They're slicing their company ownership into fewer pieces, allowing each shareholder to own a more significant percentage of the company. Buybacks can be tax-efficient for investors because they only indirectly affect the stock price. Dividends are taxed as income.

Companies have been rewarding shareholders more than ever, drawing heightened criticism and regulation. Last year, the largest 3,000 US companies engaged in a record $1.3 trillion of share buybacks and have already matched that pace to start 2023. The world's largest 1,200 corporations are on track to pay a record $1.6 trillion in dividends this year. Amidst this massive expansion of shareholder rewards, financial regulators have mandated more disclosures about buybacks, President Biden called for quadrupling the tax on share repurchases, and House Democrats have reintroduced a bill to ban open market stock buybacks altogether. The debate is likely only heating up.

Why do companies like buybacks?

They're great for shareholders, which means investors and executives (who mostly get paid in stock) love them. If employees get paid in stock, it helps them too. If companies regularly issue new shares to investors to raise funding or to pay employees, occasionally cutting back the number of outstanding shares reduces the dilution of the stock.

Share repurchase plans offer a short-term boost to a company's stock price. One key metric investors use to value a stock is the company's earnings per share (EPS). Earnings is another word for profit, and this metric evaluates profitability per the number of outstanding shares of stock. Decreasing the number of shares immediately makes the stock more valuable, driving the price higher.

Buybacks are also a good way for executives to signal optimism. If you have enough money to spend on shareholder rewards and financial housekeeping, your business must be healthy.

Is rewarding shareholders evil?

Of course, it isn't. Investors put their money into the company and should get something in return. Not every business is built for growth and expansion. Sharing profits with investors maintains their access to funding. The real question is whether a short-term focus on shareholders should be the highest priority. If you ask one of the most successful shareholders of all time whether buybacks are good practice, Warren Buffet, he'll get defensive.

When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).

Warren Buffett, Letter to the Shareholders of Berkshire Hathaway Inc

He’s right - shareholders benefit. While we hope to be a driving force in turning more consumers and employees into shareholders, that's not the case today. Buffett seems to think harming shareholders means harming everybody, but shareholders are a small, privileged subset of our country. That's the conflict embedded in the perspective of one human whose personal wealth exceeds the cumulative wealth of more than 100 out of 195 global countries. The wealthiest 10% of Americans own 89% of all US stocks. The bottom 50% own less than 1%. Even looking at pension plans and defined contribution plans, the bottom 50% owns only 2% and 5%, respectively. Measuring the consequences of corporate decisions by the magnitude of a stock price wildly minimizes the reality of that company's existence and its responsibilities to its stakeholders - employees, communities, customers, and the environment. We would love for more stakeholders to become shareholders, merging priorities, but until then, companies must evaluate the tradeoffs.

While buybacks themselves are practical financial strategies, prioritization of buybacks over other corporate spending demonstrates executive values. Raising dividends and increasing buybacks while laying off thousands of workers and squashing employee demands for safety, benefits, and a living wage is where questions of morality enter the picture. Disney, 3M, Meta, Boeing, Google, Apple, and other enormously-profitable corporations have slashed thousands of jobs this year while spending billions on dividends and buybacks, many expanding their buyback programs at the same time. Will these tradeoffs prove worth it?

Is paying shareholders cash the best thing to do with profits?

Those benefiting from the system are quick to discount alternatives, but there can be a better system. There are other ways companies spend money to improve their financial performance.

The challenges in our society could be better addressed through innovation than shareholder rewards. The United States is on pace to spend $946 billion in research and development this year. The biggest 500 US companies will spend nearly 3x that on dividends and buybacks this year while pulling back on capital investments in new technology, property, and equipment.

Employees need to be considered investments rather than expenses. Investing in workers increases productivity, reduces turnover costs, and improves financial performance. Improving employee wellness delivers better productivity and retention, but more than half of the full-time employees of the largest 1,000 companies aren't earning a wage that meets basic living expenses. Companies prioritizing stakeholders perform better in the market because employees create value. In 1975, only 17% of the value on corporate balance sheets was intangible assets - intellectual property, patents, brands, and other non-physical creations. Today, intangible assets count for 90% of the value of the S&P 500. Investing in employees fuels innovation and growth.

Of course, investments - in employees, training, research, or infrastructure, are always a risk. They need to be done correctly to be worth it. For many energy companies over the past decade, prioritizing their dividends generated better returns than investing in oil and gas projects. Based on the success of clean energy stocks in the past few years, one has to wonder whether the type of reinvestment, not reinvestment itself, was the problem.

Either way, paying investors to like your stock is a much easier way to guarantee stock price improvements. When executives get paid tens of millions of dollars based on whether the stock price goes up over a 2-5 year period, it's hard to imagine their priorities changing.

You’re doing great,

The Scoop Team

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