Editorial

Stock buybacks a warning signal

Jan 5, 2014 @ 12:01 am

+ Zoom

Companies in the U.S. have been criticized for using corporate money to repurchase shares rather than for growth by investing in research and development.

In fact, share repurchases in 2013 topped $750 billion as the year ended, and some of that was borrowed money. Companies have also paid out significant amounts in -dividends.

This pattern could be a warning signal to investors that corporate management has little faith that the economy will reward investment in projects that will expand companies, or that management has run out of ideas for corporate growth. Either would be bad for investors. The last time companies paid out so much to buy back stock was 2007, immediately before the financial crisis.

Several factors influence corporate decisions to invest in share buybacks rather than in innovation and expansion. In some companies, it's likely that all of the factors are at work at once.

EARNINGS PER SHARE

Sometimes management is feathering its own nest with buybacks because the strategy reduces the number of shares outstanding and thus increases earnings per share. Many incentive pay packages for top executives are tied to increasing earnings per share. Unfortunately, increasing earnings per share in this way may fool the unwary investor into believing that the company is growing when it is not.

In other cases, corporate management may truly be concerned about the slow growth in the economy, as well as the lack of final demand for products, and decide to return some of the cash to shareholders, who might be able to reinvest it for better returns rather than hold it hostage.

The possibility that management at so many companies might have returned cash to investors because they had run out of ideas for investment in the companies' industries is of particular concern because it suggests slow growth in the economy in the months and years ahead.

Whatever the reason, the high level of share repurchases is a warning signal that all may not be well in corporate America despite the record-setting stock market rally. It might be a false alarm, but investors and their advisers should pay attention just in case.

0
Comments

What do you think?

View comments

Recommended for you

Featured video

INTV

Ed Slott: Many investors are still not using this IRA strategy to save on taxes

If you have a client who has an IRA that is subject to required minimum distributions and they're donating to charity, they should be using qualified charitable distributions, according to Ed Slott, founder of Ed Slott's Elite IRA Advisor Group.

Video Spotlight

Will It Last As Long As Your Clients Do?

Sponsored by Prudential

Video Spotlight

The Catalyst

Sponsored by Pershing

Latest news & opinion

New military pension rules need financial advisers to step up and serve

Matching defined contribution plan expected to see more money, more need for sound advice.

Brian Block's $4 million bonus was tied to a key metric at ARCP

Prosecution rests case in fraud trial against CFO of American Realty Capital Properties.

Edward Jones is winning the Google search war

Brokerage firm's digital marketing investment helps land it at the top of local and overall search engine results, report finds.

Voya's win in 401(k) fee suit involving Financial Engines bodes well for other record keepers

Fidelity, Aon Hewitt and Xerox HR Solutions are currently defending against similar fiduciary-breach claims.

Collective investment trusts getting more attention from 401(k) advisers

The funds are catching on due largely to lower costs and more product availability, but come with some inherent drawbacks.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print