Stock Buybacks Offer Shareholders Mixed BlessingsBy
Corporations are once again devoting billions of dollars to stock buybacks, using a record amount of cash on their books to provide a quick reward for shareholders. U.S. public companies have announced plans to buy back $106.1 billion in stock since the start of 2010, according to TrimTabs Investment Research. By contrast, companies announced plans for $132.5 billion in buybacks in all of 2009.
In recent weeks, Raytheon (RTN), Starbucks (SBUX), and PepsiCo (PEP) have all boosted their share repurchase plans. On Mar. 15, PepsiCo pledged an extra $15 billion in stock buybacks through June 2013 while also raising its dividend 7%. "The board's action reflects continued confidence in the growth of our business and our commitment to providing strong cash returns to our shareholders," said Chairman and Chief Executive Indra Nooyi in a statement. Raytheon boosted its dividend and said it will buy $2 billion of its stock. On Mar. 24, Starbucks expanded a buyback program and announced its first dividend.
In theory, equity buybacks add upward pressure on a stock price while also boosting earnings per share by reducing the number of shares outstanding. They also can betray a lack of more productive uses of cash. "Stock buyback programs represent a failure of management to find attractive internal investments," says John Brady, senior vice-president at MF Global (MF).
Not Just Lip Service
Companies aren't just promising to buy back their own shares. In the fourth quarter of 2009, companies in the S&P 500 index actually did purchase $47.8 billion of their own shares, up 37.2% from the previous quarter, according to Standard & Poor's (MHP) data released Mar. 29.
Both plan announcements and actual repurchases are well below the rapid pace of buybacks in 2007. Last quarter's share purchases were 72% below the $172 billion in equity buybacks in the third quarter of 2007, a record amount for one quarter. In all of 2007, companies announced $809.5 billion in buybacks, while actually purchasing $589.1 billion in shares.
If recent news and data suggest companies are returning to buybacks, one explanation is record amounts of cash on corporate balance sheets, market experts say. "Corporate profits are rebounding tremendously, and they have this money to put to work," says Mike O'Rourke, chief market strategist at New York brokerage BTIG. In the fourth quarter of 2009, average earnings for the S&P 500 rose 97.9% from the previous year, according to Bloomberg. Standard & Poor's estimates that S&P 500 companies had $831 billion available at the end of 2009, according to a measure that excludes utilities, financial, and transportation companies, all of which typically hold a lot of cash for operations. Despite a brutal recession, cash balances are 27% higher than at the end of 2008. All that cash comes from a variety of sources: Companies have slashed costs, cancelled capital spending, issued new shares, and taken advantage of low interest rates to borrow money.
Flexibility Instead of Commitment
Companies aren't "confident enough in the recovery" to start spending on irreversible bets such as acquisitions or big capital spending projects, says Vincent Deluard, TrimTabs' global equity strategist. Quarterly dividends, another method of rewarding shareholders, have a downside for companies: Once increased, dividends are expected to be paid out regularly each quarter; otherwise, the market could penalize the companies' shares harshly. Buyback plans—spread over a year or more, often without a purchase schedule—give companies much more flexibility. Moreover, companies are not required to buy all the shares they say they will, giving management flexibility with cash. "Buybacks are the easiest way to return cash to shareholders without committing to anything," Deluard says.
Given worries about the economy, companies remain cautious about using their cash, including for buybacks. Even with the rebound in buybacks last quarter, the S&P 500 share count actually increased, notes Howard Silverblatt, S&P senior index analyst. "Companies are going to need a couple quarters to see everything is kosher," he says. Assuming the economy continues to recover, he expects companies to wait until the second half of 2010 before making firm commitments to share purchases, capital spending, or dividends. (Silverblatt is a contributor to Bloomberg BusinessWeek's Investing Insights blog.)
Investors and executives have reasons to hope better uses can be found for the cash as the economy recovers. U.S. companies have an "awful" track record of buying stock in a way that provides shareholders with long-term benefits, Brady says. A prime reason is that purchases are poorly timed. Consider that record share buybacks of $172 billion occurred in the third quarter of 2007, which ended just days before the S&P 500 hit its all-time high on Oct. 9, 2007. Companies were buying some expensive shares: The S&P fell 57% in the next 17 months. When major stock indexes hit bottom in the first quarter of 2009, S&P 500 companies bought back just $24.2 billion in equity.
Investors are told to buy low and sell high. When it comes to buybacks, recent history suggests U.S. companies do the opposite. When stock markets fall, as they did a year ago, cautious executives slash spending on everything, including share repurchases. It's only when the economy is booming—and stocks are expensive—that managers find the confidence and cash to fully embrace buybacks.