Corporate buybacks - everyone's been doing it, even Wall Street darlings like Apple (AAPL).
In this installment of Investing 101, we look at why companies engage in the purchase of their own shares.
While management may say they are buying shares because company stock is “cheap” and they want to return money to shareholders, ostensibly what they’re doing is propping up the stock price and rewarding executives compensated with stock. A new study in the Harvard Business Review says as much.
In this month’s issue, from 2003 through 2012, 449 of the S&P 500 companies spent 91% of their earnings on dividends and stock buybacks, which "left very little for investments in productive capabilities or higher incomes for employees,” says University of Massachusetts economics professor William Lazonick in the HBR. Lazonick says this because “stock-based instruments make up the majority of [management] pay, and in the short term buybacks drive up stock prices.”
Are there other, more legitimate reasons for why share buybacks should be done? Danielle Hughes and her company Divine Capital have been studying this phenomenon for quite some time.
“The reason why they want to buy back their stock is that they have a certain number of shares outstanding, and they want to reduce the number of shares outstanding to have bigger earnings per share, and they do that buy buying back the stock and retiring it into treasury,” she says in the attached video.
Hughes points out one of the reasons why buybacks are so popular is that borrowing costs are so low for corporations since credit is so cheap (something which, she points out, average Americans don’t have access to.)
While management and corporate boards sometimes believe they get the “most bang for their buck” buying back shares, Hughes believes otherwise. Hughes would rather see the companies spend on capital expenditures, or cap-ex, which are “real productive assets.”
When Hughes evaluates companies, the ones she likes best still return some capital to shareholders via buybacks, but also focus on dividends and spending on cap-ex. Those are the key factors to look at, she says, and from her company’s research, only a quarter of S&P 500 (^GSPC) companies actually do this.
Programming Note: Tonight President Obama will address the nation, discussing the growing threat of the extremist group IS, the Islamic State, in Iraq and Syria. Yahoo will present live coverage beginning at 8:45pm ET anchored by Katie Couric and featuring Yahoo News team members Bianna Golodryga, Michael Isikoff, and Matt Bai. Your questions will be answered. Tweet @katiecouric using #askyahoonews.
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