Commentary: The Buyback Boom Is Mostly A BoonChristopher Farrell
A healthy narcissism thrives in Corporate America, it seems. On Mar. 30, Texaco Inc. said it planned to buy back up to $1 billion of its common stock, just after completing a $650 million stock repurchase. General Motors Corp. is buying back $4 billion of its equity. Intel Corp. just approved another stock buyback program of up to 100 million shares. In 1997, 1,273 companies said that they would spend a mind-boggling $180 billion repurchasing their own shares, according to Securities Data Co.
Do these deals make economic sense? Or are buybacks just another financial gimmick to boost the stock price? Shouldn't companies be putting their extra cash in plant and equipment instead? Is the long-term health of U.S. companies--and the economy itself--being sacrificed for a quick buck?
STARTUP CAPITAL. By and large, such fears are misplaced. Buybacks benefit the companies, their shareholders, and the economy. Certainly, investment in plant and equipment is not going begging: In the past five years, total fixed investment has risen at a sound 8.7% annual rate and corporate cash flow has increased at 7.3% per annum, after dividend payments. Says Arvind Sodhani, Intel's treasurer: "We have a strong cash position, and we can fund our growth through cash earned on sales."
Stock buybacks are a way of returning cash to millions of shareholders who may then reinvest their gains elsewhere in the economy where the returns are higher. "With stock buybacks, you get money going from IBM and other companies to thousands of Yahoo!s," says Mark M. Zandi, economist at Regional Financial Associates Inc. Money from buybacks, in large part, is fueling the boom in initial public offerings of high-tech, cutting-edge outfits, thus increasing the productivity of the economy.
Companies are saving their shareholders billions in taxes by buying back stock rather than simply increasing the dividend. Dividend payments to taxpaying shareholders are taxed twice: once at the corporate and again at the individual level. In sharp contrast, shareholders who decide to sell their stock are often taxed at the much lower capital-gains rate.
At the same time, owners of 401(k), 403(b), and other tax-sheltered investment plans might prefer a steady stream of dividends. "Shareholders now have more choice about how they receive their cash flow," says Amar Bhide of the Harvard business school.
Buybacks tend to boost stock market returns over the long run. Melissa Brown, quantitative analyst at Prudential Securities Inc., studied several thousand large-, mid-, and small-capitalization companies from 1978 through 1996. She compared the stock returns of companies that reduced their shares outstanding by 5% or more with the average return of a peer group. She found that companies with a stock buyback program did better over time. For example, in the group of large-cap companies, she found that those with a stock-buyback program gained an average of 21% a year, vs. an appreciation of 15.5% for the group as a whole over the eight-year period. Other studies tend to show a long-term gain on the order of 3% higher for companies that buy back stock, says Steven Kaplan, finance professor at the University of Chicago. Part of the gain, he adds, comes from these companies managing their businesses more efficiently.
BUYING HIGH. Many stock buybacks don't shrink the total equity pool of a company. Instead, repurchases are used to offset employee stock options and prevent shareholder dilution. What's more, stock options can enhance employee productivity and, hence, boost stock market returns.
Still, aren't companies crazy to buy their stock with the Dow Jones industrial average hovering at record levels? Problem is, market valuations have been stretched for years and, with the benefit of hindsight, past repurchases tend to look pretty savvy today.
To be sure, buybacks are no financial elixir. They are not a replacement for strategies to open up new markets, nurture innovation, and boost profits. Nevertheless, efficiency is not confined to the factory floor. As Paul D. Grangaard, head of corporate finance at the investment banking firm Piper Jaffray Cos., puts it: "Stock buybacks should be a standard part of managing the balance sheet and the company."