The sweeping tax reform measures passed in 2017
were supposed to spur corporations to reinvest
profits back into research and paying their own
employees, and by extension, create new jobs.
We are giving them a big beautiful Christmas
present in the form of a tremendous tax cut.
It'll also be tax reform and it'll create jobs.
The one-and-a-half trillion dollar plan took
effect in January 2018.
It lowered the corporate tax rate from 35 percent
to 21 percent and the hope was companies would
use that money for capital expenditures.
That includes physical equipment, offices in
factories and software or intellectual
property—and that would create jobs and other
employment opportunities.
Many businesses did spend more on internal
projects, at least initially. In
the first half of 2018, business spending was at
$341 billion, a 19 percent increase over 2017,
and money spent on research and development hit
$147 billion—a 14 percent increase.
But business investment slowed later in the year
as concerns about the economy grew. At
the same time, companies announced buybacks to
the tune of a record $1.1
trillion worth of their own stock.
The stock buyback debate has drawn the ire of
politicians on both sides of the aisle.
In an editorial in The New York Times, Senators
Chuck Schumer and Bernie Sanders pledged to
introduce buyback legislation.
Their bill would encourage companies to do
something for workers before they could buy back
stock and pledged to set minimum requirements for
investment in workers and the long-term strength
of the company as a precondition for corporation
entering into a share buyback plan.
At the same time, Republican Senator Marco Rubio
has suggested Congress raise the rate on capital
gains to discourage buybacks.
The mere suggestion Congress should address
buybacks drew a swift response.
This is basically legislators saying we know
better how to deploy corporate capital than the
managers in the business.
Now, let's look to history again.
Where has that led people?
When government officials decide that they're the
ones who can micromanage business—they're talking
about exactly how much to pay people how much
benefits to give them, that they can't do share
buybacks.
So what are stock buybacks? Buybacks
often occur when a company's CFO thinks a stock
is undervalued.
When a company has excess cash, it can do one of
several things: Invest that money into their
business by upgrading equipment or real
estate, acquire another business, pay dividends
directly to shareholders or buyback its own
shares.
Buybacks come in different shapes and sizes. And
while they can be indicative of a company's
performance, that's not always the case.
Buybacks by themselves are no reason to own a
stock and in some circumstances are actually
reason to sell it.
I think you never want to own a stock of a
company is wasting the money it needs to survive
on useless buybacks, or even worse, spending
money it doesn't even have an activity as
fruitless as repurchasing its stock
at what you call a bottom. And
you shouldn't rely on even the largest buyback to
help prop up a stock, if the situation's dire.
The first and most obvious benefit is a boost in
the stock's price.
When a company buys back shares, it reduces the
number of shares outstanding.
If profitability remains the same, it will
increase a company's earnings per share. Buybacks
are generally taxed at the capital gains rate
while dividends are taxed as income.
And if the stock is owned beyond one year, the
cap gains rate is even lower.
Buybacks can signal good cash flow.
Finally a company that has excess cash to buy
back shares is generally in good shape when it
comes to cash flow, which boosts investor
confidence over the long term. Of
the companies that initiated buybacks in the last
year, these were the best performers.
Critics say buybacks are a form of financial
engineering that does nothing to improve
business. They can also provide cover for poor
financials. The artificial lift a buyback often
brings can mask greater problems at a company.
Companies are notoriously bad at timing the
repurchase of shares. As
a result, they often end up paying more for
shares than they should.
Legendary investor Charlie Munger sees that as
one of the biggest problems of buybacks.
Generally speaking, I'm restrained in my
enthusiasm for politicians telling corporations
what they should do.
But, I will say this: When it was a very good
idea for companies to buy back their stock, they
didn't do very much.
And when the stocks got so high priced that it's
frequently a bad idea, they're doing a lot.
Welcome to adult life.
This is the way it is. But
it's questionable at the present levels whether
a lot of it's smart. Was Eddie Lampert smart to
buy so much Sears Roebuck? No. And there's a lot of that kind of mistake that's been made.
The short-term spike that stocks often get can
allow insiders to profit.
Most times, those insiders are executives or
founders since they're often major shareholders
in their own companies.
Recently, Senator Chris Van Hollen proposed
barring corporate insiders from selling stock
within a prescribed time after a buyback was
announced. SEC Commissioner Robert Jackson, Jr.,
recently expressed his belief that most buybacks
are better for executives than shareholders.
Last year, he appeared on CNBC to discuss why
buyback rules should be re-examined.
After the Trump tax cuts passed billions upon
billions of dollars have been used for
shareholder buybacks in large public companies
across the United States. And
in the speech that I gave, I showed that those
buybacks are accompanied by, at the same time the
company buys back shares, the executive sells
into the buyback.
Now, we were clear in this speech that that's not
necessarily insider trading or fraud but it is
troubling, because when an executive does a
buyback they're suggesting to the market that the
stock is cheap.
And the question I'm asking is, if the stock is
cheap, then why is the executive selling into the
buyback.
As a result, there may be new momentum within the
SEC to change the rules.
Jackson responded to Van Hollen's concerns with a
letter. The commissioner said he found that from
January 2017 through the end of 2018, insiders
sell more stock right after buyback
announcements. That indicated to Jackson the
repurchases were more geared to executive
enrichment and less to the interests of the
shareholders or the benefit of the company.
Another problem with buybacks is that share prices
will eventually settle back to their previous
levels when investors realize the company's done
nothing to increase value.
And finally, some investors just prefer dividends
over buybacks.
These were the worst performers among companies
that have initiated buybacks.
So what, if anything, should be done to stem the
buyback tide?
While many Republicans believe there's nothing to
be fixed, there are several suggestions floating
around Washington.
One from Senator Tammy Baldwin would eliminate
the 1982 regulatory change that enabled such
large buybacks in the first place.
Schumer and Sanders would tie buybacks to a $15
minimum wage and other improved worker benefits.
And Senator Rubio would tweak the tax code to
eliminate what he calls an artificial incentive
for buybacks.
Jackson has suggested an open comment period on
rules for stock buybacks.
Regardless it appears the firestorm about stock
buybacks is just beginning Schumer's office
didn't offer specific time on when he might
introduce the legislation.
The bill is unlikely to make it through the
Senate, though, or make it to President Trump's
desk.