2018 has been a big year for stock buybacks. But what the f**k are stock buybacks and what do they mean for you?
In fact, 2018 has been a record year for stock buybacks. By the end of the year, companies are predicted to have spent $1 trillion on buybacks.
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What Are Stock Buybacks?
A buyback, also known as a share repurchase, is when a company buys its outstanding shares to reduce the number of available shares on the open market.
This practice was illegal for decades because it was considered a form of stock manipulation. But that changed in 1982 when Ronald Reagan appointed a Wall Street guy to head the SEC, and because a Republican never saw a regulation he liked unless it has to do with uteruses, a legal process was created to allow buybacks.
In 1982, the SEC adopted rule 10b-18, which provides a “safe harbor” for companies in stock buybacks. As long as companies operate within specific parameters like not buying more than 25% of the stock’s average daily trading volume in a single day, stock buybacks are perfectly legal.
Why Companies Perform Buybacks
There are plenty of things a company can spend money on so why choose buybacks?
A buyback allows companies to invest in themselves. A company may feel its shares are undervalued and do a buyback to boost share price and give investors a return. And because the company is bullish on its current operations, a buyback also increases the proportion of earnings that a share is allocated. This will raise the stock price if the same price-to-earnings (P/E) ratio is maintained.
Buybacks also increase the value of remaining shares available by reducing the supply. Some companies use buybacks as a way to prevent other shareholders from taking a controlling stake and strong-arming companies into doing things that would benefit those stakeholders but maybe not the company.
Another reason for a buyback is for compensation purposes. Companies often award their corporate employees with stock and stock options. This benefits the existing shareholders and board members who are usually paid in stock options.
This money could be used in better ways like investing in research and development or, building new factories so why not do that? But growing a company may not always be a positive thing, it’s risky.
Investing in a new product is a gamble because the product could be a failure. But something has to be done with all the surplus money because investors don’t buy stocks in companies that sit on big piles of cash. Stock buybacks are the less risky way to spend that money.
Companies could use the cash to pay out dividends, but dividend income is taxed differently than the income garnered from selling stocks, so it’s more lucrative to sell the stock than take the dividends.
Not all investors think buybacks are a good thing. In 2014, Larry Fink, the CEO of BlackRock, one of the largest investment companies in the world, warned US companies to slow down on buybacks and dividends.
“We certainly believe that returning cash to shareholders should be part of a balanced capital strategy; however, when done for the wrong reasons and at the expense of capital investment, it can jeopardize a company’s ability to generate sustainable long-term returns,” he wrote in a letter.
So why are so many buybacks happening now? The GOP tax cuts. The economy is doing well, and a lot of companies have a surplus of cash and don’t want to sit on it because it puts them at risk of being bought and it pisses off shareholders who want that money returned to them in either dividends or an increase in stock value.
Shareholder primacy on Wall Street has been on the rise. So-called “activist investors” who buy large numbers of a company’s shares to try to get seats on the board or effect change within the company have contributed to a rise in “short-termism” on Wall Street.
Which Companies Are Doing Buybacks?
Which companies are taking advantage of the GOP’s generosity and are they using it to boost worker wages as Republicans promised would happen, in the form of trickle downs?
Those generous Waltons spent their gluttonous portion of the tax cut on $20 billion in buybacks. They promised workers to increase their minimum wage to $11 an hour and give “eligible” employees a one time $1,000 bonus.
If Walmart wanted to spend that $20 billion on workers instead, according to a report released by the left-leaning think tank the Roosevelt Institute this week, it could increase their wages by $5.66 an hour to a $16.66 base wage. Or buy its employees Walmart stock doling out about 113 Walmart shares — currently valued at about $83 apiece — to each.
Had they done that it might have lowered your tax bill. You subsidize the low wages Walmart pays through welfare benefits, including EBT dollars their employees have to claim because Walmart doesn’t pay a living wage.
And guess what’s even better? Billions of those EBT dollars are spent…You guessed it! At Walmart.
What about Harley Davidson? The company announced a $700 million buyback just after announcing the closure of a Kansas City plant meaning 800 people not only didn’t get some of that sweet, sweet trickle down money in the form of a raise but lost their jobs.
How about that bastion of ethics Wells Fargo? How did they spend their tax cut? Compensate the two million customers they opened fake accounts for? Reimburse the owners of the 413 cars they illegally repossessed?
How Does This Affect You?
If you own stock in companies that are doing buybacks or you have pensions, the act of buybacks will increase the value per share. This will give you more money in the short term.
However, only a small number of people own enough stock for this to affect them positivity. Most stock is owned by a very small group of people who stand to benefit the most from this short-term gain.
Those who champion buybacks will say that because many Americans own stock, they benefit from buybacks. But only slightly more than half of Americans own stock, the richest 10% own 80% of all stock shares while the bottom 80% own a mere 8%.
If companies spent their money on increasing wages than buybacks, this would benefit more people and the larger economy.
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So if you’re reading this (and you’re not John Bogle whom we have reason to believe does read us!), all these buybacks likely aren’t doing much for you.
What Should You Do?
The way to make money is to buy low and sell high right? But stock prices are high which means it’s not a good time to buy. That doesn’t mean you should sit on the sidelines though. We don’t know and neither does anyone else, how long this is going to last. And the longer you sit on the sidelines, the less time your money has to grow.
If you’re not currently investing, open a Betterment account. Because it’s not a buyer’s market, you don’t want to dump a big stack of cash it all at once. Instead, use dollar cost averaging to drip your money into the market over time.
If you’re already investing, stay the course. Do not start selling. But you may consider holding some of the money you invest every month back for a little while. Rather than investing at the same rate, put some of that money into an opportunity fund.
When the correction comes, that’s the time to buy and you’ll have extra money to scoop up all those bargains the chicken littles are selling at rock bottom prices!
How Can We Fix This?
The only way to stop or slow this would be through government regulations and since the GOP Congress is planning to deregulate stuff like asbestos, worker safety measures, overtime protections, and fiduciary rules (this is another depressing list that is endless) don’t hold your breath.
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