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Well that was a bust.
For the past several years, America’s corporations have been by far the biggest buyers of their own stock. From 2016 through 2019, our big cap enterprises repurchased a staggering $2.5 trillion in shares, according to a November study by Goldman Sachs. Last year’s outlays of $480 billion in dividends and buybacks by the S&P 500 amounted to over 100% of their free cash flow––and by the way, buybacks now far exceed dividends as corporate America’s favored vehicle for what’s known as “returning cash to shareholders.”
Buybacks are indeed a good idea under two conditions. First, the company can’t find profitable ways to reinvest part of its ample earnings, generally the case with big, mature businesses from automakers to consumer goods purveyors. Second, management perceives their shares as a bargain. For example, if their stock is selling at an 19 price-to-earnings multiple, and the brass believes that its real value is more like 22 time earnings, then if they’re correct, handing each shareholder a bigger ownership stake through buying back shares at a discount will enhance their returns in the future. That practice follows Warren Buffett’s maxim that repurchases are smart when a stock is selling below its “intrinsic value.”
But keep in mind, investors themselves only translate buybacks into cash if each year they sell the percentage of their shares that equals the percentage by which the buybacks lowered the company’s share count. I’ll save you from all the math, but if you own stock in XYZ Corp, and management repurchased 5% of its shares last year, you could sell 5% of your shares, pocket the cash, and still own the same percentage of XYZ you held the year before.
But this marvelous formula only works if valuations were reasonable when companies did the gorging, and don’t reset at much lower levels.
We’ve just experienced just such an epic repricing. At its all-time high on February 19, the S&P traded at a lofty P/E of 24. As of the market close on Monday, March 16, that benchmark has dropped to 17.0, a number that based on record earnings that will soon retreat, still looks frothy.
Remember, the purpose of buybacks is to raise earnings per share and hand investors capital gains. As an investor, if you’d sold a portion of your holdings every year and banked the gains, you’d be a lot better off than if you’d held all of your stock. If you didn’t sell anything, you’ve ended up owning a bigger and bigger percentage of, say, XYZ, and XYZ is now worth 30% less than than it was three weeks ago. The fall in the share price far outweighed the increase in your stake. Because the selloff is so steep and broad, a giant portion of the erstwhile benefits of the $1.25 trillion in buybacks since August of 2017, when the S&P stood at today’s levels, have evaporated.
So repurchases suddenly look like a raw deal, at least in the short term. In the long-run, it’s not yet clear. For example, the big banks, including J.P. Morgan, Bank of America and Wells Fargo, were purchasing at PEs in the low to middle single digits, and incredible as it may seem today, those buys may look well founded a couple of years from now. (For now, eight of the largest banks announced they are suspending buybacks to free up capital to lend to businesses and consumers.)
On the other hand, the big four airlines, United Continental, Southwest, Delta and American, lavished $31 billion on their own shares from the start of fiscal 2015 through 2019, equal to two-thirds of their net earnings. In every case, their shares were higher when at the start of that five year period than they are today, generally by a lot; shares are down around 70% at both American and United. Their shares were mostly above the 2015 starting point during the entire time they were buying in all that stock. It’s unlikely that staunch loyalists who didn’t cash in shares each year will ever see any benefits from that buyback extravaganza.
Conclusion: Markets have reset prices based on the view that the world is a much riskier place than it appeared just three weeks ago. That makes what management touted as great deals for years look terrible today. In many cases, CEOs and boards should have known better, and returned those billions in dividends instead. The selloff has revealed the dark side of buybacks. When stocks get repriced, the gains from repurchases vanish in a hurry, with in many cases, little prospect of returning.
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