Stock buybacks are once again in the news, with Democratic presidential candidate Hillary Clinton criticizing companies for spending their cash on buybacks rather than investing it.
Buybacks have been controversial for many years. Defenders argue that if corporate management cannot see profitable investments on which to spend cash, then it ought to give it back to the shareholders who might find good uses for it, including buying other stocks.
While management could give it back in higher dividends,
dividend increases are long-term commitments by the company because they are hard to reverse. If a company has to cut its
dividend, that can cause significant declines in its stock price. As a result, many corporate managers prefer share buyback programs, which do not imply a long-term commitment and can be shut off after reaching a target amount, to be repeated in the future if desired.
FINANCIAL ENGINEERING
Critics argue that companies use stock buybacks for financial engineering. Reducing the number of shares outstanding increases the earnings per share, which can push up the share price and help executives achieve performance compensation targets. They should instead be investing it in new productivity-enhancing plants and equipment.
Defenders say companies hold back from investing in new plants and equipment not because they want to use the money for financial engineering or because they don't have good investment ideas, but because consumer demand is weak around the world and the investment might not pay off.
According to one estimate, the number of U.S. shares outstanding has declined 6% since 2009, though the pace of share repurchases has slowed this year. In the first quarter of 2014, companies bought back stock worth $159 billion, but in the first quarter of 2015 that declined to $144 billion.
The decline in share repurchases possibly indicates that companies are expecting, or have experienced, weaknesses in earnings and are husbanding cash. It might also be an indicator of stock market weakness in the coming months. It's also possible that the decline means companies now are beginning to invest some of their cash, which would be good for the economy and investors in the long run. But the evidence won't be clear for some time.
These are issues for advisers and their clients to be aware of. In addition, advisers should thoroughly vet every share repurchase offer in light of each client's unique situation and advise the client on whether to accept or ignore the offer.
