“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,” Buffett wrote in his annual letter to shareholders. “That simply isn’t the case.”
Some of America’s best-known companies are right there with him — Cisco Systems, PepsiCo, Oracle, Wells Fargo, Amgen, eBay, Mondelez, Lowe’s, Visa and Google’s parent Alphabet have all announced stock repurchases since December.
These companies and others find themselves sitting on an Everest of cash, thanks to profits pouring in faster than they can find productive ways to spend it. The profits have built up in recent years, aided by low borrowing costs, rapidly advancing technology that has reduced overhead and boosted margins, and international trade that has allowed offshore production of goods at bargain prices.
The Republicans’ corporate tax cut has bought another boon — and may mean that more cash will come home now that there’s less incentive to park it off shore.
At the end of 2017, companies in the Standard & Poor’s 500-stock index were sitting on the largest cash pile in history: nearly $1.8 trillion in cash and equivalents, according to Howard Silverblatt, a senior index analyst with S&P; Dow Jones Indices. Nearly 56 percent of that is in cash, with the rest in short-term, fixed-income securities, such as corporate and government bonds that are far less volatile than equities and earnings themselves.
So now companies are prepared to buy back their stock on the open market and put it into the company treasury, reducing the number of shares in circulation.
Unlike dividend payments, which register as income and have immediate tax consequences, stock buybacks offer a big upside for shareholders. Think of a pizza redivided from eight slices to six. It is still the same size pizza, but your slice just got bigger because there are fewer slices. The shareholder doesn’t pay taxes until selling the shares, which could be years.
“It increases share prices without giving the shareholder a tax liability,” said Ivan Feinseth, chief investment officer at Tigress Financial Partners.
Critics, as Buffett noted, slam the buybacks as a way for a company to reward its executives, Wall Street raiders and well-off American shareholders. They say that the corporate tax cut signed by President Trump in December is supercharging an already unfair playing field by giving money to companies who then pass it on to shareholders through buybacks (and cash dividends) rather than give it to workers in the form of higher wages or better benefits.
“Buybacks are not productive investments,” said Jared Bernstein, who served as the economic adviser to Vice President Joe Biden. “They enrich shareholders, not workers. And most people depend on their paychecks, not their portfolios.”
Debate over the social value of share buybacks has entered the political realm. Sen. Tammy Baldwin (D-Wis.) introduced legislation last month that would end the ability of corporations to buy back their stock on the open market, though repurchases through tender offers that are subject to greater disclosure would still be allowed.
Proponents say buybacks are an efficient way to redirect idle cash into more productive uses, eventually putting more people to work.
“If the company buys back a share of stock, they give the money to a shareholder,” said John Cochrane, a senior fellow at the Hoover Institution, a right-leaning think tank. “The shareholder, whether it’s a mutual fund or pension, goes and invests it in another company that might have something better to do with it. Money usually takes four or five steps to get anywhere, but eventually the money from the buyback makes its way into the hands of a company that isn’t going to leave it in cash. It’s going to build something new with it.”
Buybacks are expected to hit a record this year. In February alone, U.S. corporations announced a record $150.7 billion in buybacks. And companies in the United States have spent $5.1 trillion over the past 10 years on buybacks, according to Birinyi Associates.
Silverblatt, the index analyst, said he expects this year’s buybacks total to smash a high mark set 11 years ago. “We are looking for record amount of buybacks,” he said. “The highest total buybacks was $589 billion in 2007.”
The buyback announcements have been ramping up since the tax cut was passed Dec. 20.
“Companies definitely seem to be planning to use a good amount of their tax savings to buy back stock,” said David Santschi of TrimTabs Investment Research. “We’ve seen a lot of announced buybacks since the tax plan was announced.”
But even before the corporate tax cut, companies had been hoarding hundreds of billions of dollars in cash despite stepping up investments in research, development and new equipment.
“Public firms started with $3.3 trillion in cash in 2007 and accumulated 50 percent more cash over the next decade, ending with $4.9 trillion in the bank,” said Harvard law professor Jesse Fried, who is part of a team that has done extensive research on the subject and that supports buybacks. “Buybacks cannot be starving firms of cash for investment if cash stockpiles are huge and rising. If buyback alarmists were correct, investment by public firms should be declining.”
Berkshire Hathaway has $116 billion in cash. Apple’s cash pile is about $280 billion. Microsoft has about $143 billion in cash. Google parent Alphabet has about $100 billion on hand.
Buffett said at Berkshire’s shareholder meeting last year in Omaha that a Berkshire cash pile of $150 billion would be indefensible to shareholders. For 53 years, he has resisted stock buybacks and dividends, arguing that he and Berkshire Hathaway Vice Chairman Charles Munger could find better uses for the cash than shareholders.
During a Feb. 26 interview this year with CNBC’s Becky Quick, Buffett said he may give it back to investors if he cannot find a good investment at a fair price.
“It’s gone a long period now we’ve been in a bull market. And the best chance to deploy [cash] is when things are going down, obviously,” Buffett said. “The inclination might be more toward repurchase [of shares] than dividends. Because dividends have the implied promise that you keep paying them forever and not decrease them.”
Buybacks have always been legal, but they became more prevalent in the 1980s when the Securities and Exchange Commission under President Ronald Reagan loosened rules to allow companies to buy back their stock.
Think of them as dividends in disguise.
The SEC, which oversees the markets, initiated a guideline known as “Rule 10b-18,” which set up conditions allowing public company boards of directors to authorize the repurchase of shares. The conditions include public disclosure and limits on the number of shares.
There is a potential for abuse because corporate executive compensation is often tied to a manager’s ability to increase his company’s share price. And buybacks can raise the share price without the company doing anything more than spending its cash buying its own stock.
“Top executives love them,” said economist William Lazonick, a professor at the University of Massachusetts at Lowell. “It rewards them at the expense of the company and at the expense of taxpayers who create the conditions and infrastructure that allows the creation of company profits.”
Buyback defenders say that workers both in and outside the company benefit from an increase in a company’s stock price and dividend.
“Saying only rich people hold stock ignores the fact that Individual Retirement Accounts and 401(k)s and government and union pension funds own stock,” said the Hoover Institution’s Cochrane. He said many workers should be rooting for higher stock prices because well-funded pensions don’t have to cut benefits or go to taxpayers for more money.
“If you’re a taxpayer in Illinois, with its pensions deeply underwater, you better pray the stock market goes up,” Cochrane said.
The most productive stock repurchases tend to occur when a company’s share price is less than the total price for which the company could sell itself. That creates a “cheap” purchase price. Companies with good fundamentals hope those repurchases put a floor under the share price.
Some of the most vaunted names in the blue chip Dow Jones industrial average — Walmart, Boeing, Home Depot — are augmenting their returns with buybacks.
“Companies have dramatically boosted their earnings, not by selling more stuff, but by buying back stock,” CNBC correspondent Bob Pisani said in a report this year. “It means that all other things being equal, Walmart, for example, has improved its earnings by 30 percent since 2002 just by buying back stock.”
In Buffett’s case, he has said the right price for a Berkshire buyback would be below 120 percent of the conglomerate’s book value, which is assets minus liabilities and intangible assets such as brand recognition. Berkshire’s current share price of about $300,000 is about 150 percent of book value, which many think is too expensive.
“Everybody would be screaming bloody murder if he started buying back at 1.5 book value,” said Greggory Warren, a Berkshire Hathaway analyst with Morningstar. “It’s contrary to everything he has said historically.”
Problems can occur when a company repurchases its share when there are fundamental issues with the firm’s operations, as there apparently were at General Electric the past several years.
GE bought back $49 billion of its stock over three years, shoring up the price while some of the firm’s operations were foundering. The 126-year-old blue-chip company was forced to cut its dividend last year for the second time since the Great Depression. GE experienced a cash crisis exacerbated by a $15 billion liability on its long-term care insurance business. Several top executives resigned, and the stock price dropped.
“The $50 billion buyback was clearly a very poorly timed share buyback,” analyst Scott Davis of Melius Research said. “If you are a current shareholder and have been through this ringer the last few years, you’ve been abused and used.”
GE appears to have changed course. Its new chairman and chief executive, John Flannery, said in his annual letter to shareholders this year that the industrial giant is beefing up its analysis of how it deploys cash, including taking a harder look at how it evaluates the risk and return of share repurchases, dividends and acquisitions.
“We really want to move the company . . . into a balanced total shareholder return of a mix of dividends and mix of organic investment and mix of share buyback when that makes sense,” Flannery said at an investor event. “We’re not anticipating much [in buybacks] in the short run right now.”
Corporate raiders have expanded their own fortunes by pestering companies to spend their cash piles buying back shares and increasing the stock price rather than sitting on that money. Investor Carl Icahn pressured iPhone maker Apple and chief executive Tim Cook to expand the buybacks that the company already had underway to raise the share price. Icahn earned a $2 billion profit when he finally sold his Apple shares.
“Buybacks were central to how Icahn made $2 billion in gains from buying and selling Apple shares,” said Lazonick, a critic of buybacks who called the $81 billion that Apple spent in 2014 and 2015 to buy back its shares the most misguided buyback in recent memory.
Cook “should be out there saying every company this profitable should be paying higher taxes rather than doing buybacks. We should make sure the thousands of employees in Apple stores, the vast majority of which are dead-end jobs, we should think of that as the start of their career.”
Icahn did not respond to a request for comment.
Apple already pays a lot of taxes. It is the largest U.S. taxpayer and anticipates a $38 billion tax payment as the company repatriates cash held in overseas accounts.
An Apple spokesman declined to comment for this article, referring The Washington Post to January reports that the iPhone maker was issuing stock grants to most employees, planning to spend $30 billion in the United States over five years, hiring 20,000 new employees and creating additional data centers and technical support facilities.
Lazonick said companies should serve other missions than their shareholders/owners.
“One thing companies have historically done is they have used their profits to keep people employed, give them higher and better wages and reward them for the productivity from that labor force that has generated the profits,” Lazonick said. “I call it retain and reinvest.”
Proponents say that buybacks help accomplish that mission, if sometimes indirectly.
“That money doesn’t go into a black hole,” said economist Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office. “It goes into a financial market somewhere. Another entity uses that money to make investments that kick off a chain of events that leads to higher capital for workers, higher wages, higher productivity. And that’s what you want.”