A Different Perspective on the 2018 Buyback Trend
Clifford Asness, managing and founding principal at AQR Capital Management, recently published a Wall Street Journal Opinion article titled, Buyback Derangement Syndrome. The article describes the increasing attacks against corporate buybacks, including claims that buybacks are “killing the American economy.” Asness argues that these claims are mostly baseless and despite the legion of attempts, there is no real case against buybacks. “Americans have lots to debate, and those critical of public corporations likely have many other worthwhile points to make,” according to Asness. “They should drop nefarious buybacks from their retinue of accusations and focus on the real problems.”
Both Harvard Business Review and AQR published findings concluding that record buybacks are occurring with record levels of investment and that buybacks and investment are correlated. Rephrased, companies that are not investing are also not doing buybacks. The Harvard Business Review article also concludes that when considering levels of R&D-adjusted net income, there has been no dramatic increase in shareholder payouts, which include buybacks (see Exhibit 1 and Exhibit 2). Furthermore, according to our research, although the dollar value of buybacks is up dramatically in 2018, the number of buyback announcements 2018 YTD is lower than previous years (see Exhibit 3).
So why are so many people suffering from buyback derangement syndrome?
First, the dollar value of the announcements this year is certainly setting records. As of August 27, the largest 3,000 U.S. companies have announced more than $770 billion in buybacks. Second, considering most of this hype started after tax reform, the focus is likely politically motivated. The media picked up on the story that companies are using tax reform at the expense of the average American and did not find it hard to support those claims with significant buyback announcements occurring almost daily .
The problem is that few investors have bothered to take a deeper dive and understand what is going on. The actual number of buyback authorizations is only average this year, meaning that tax reform did not suddenly fuel every company to start returning cash. In fact, the research shows that the companies investing are also the ones authorizing the buybacks. So, what is really going on?
In many cases, companies that continue to invest and grow profitability are now suddenly seeing decreased tax rates, as well as the ability to repatriate their significant overseas profits at a favorable tax rate. Because these companies do not have immediate investment opportunities to put this cash to work, many are likely using a buyback as an “option” to return capital to shareholders if better investment opportunities do not arise. In contrast, the market would likely treat an increased dividend as an “obligation.” If a better investment opportunity arose and the company needed the excess cash, it would need to cut its dividend or raise capital. The market has a history of punishing companies that cut or eliminate their dividend. A company that uses a buyback as an option can simply not repurchase their stock and let the buyback authorization expire without a market reaction.
When looking at buybacks from this perspective, it seems companies are taking smart actions. Additionally, many of these companies see their stock as a good investment now given the narrow leadership of the market; therefore only a few stocks account for most of the S&P 500 return. There are certainly some companies doing buybacks for the wrong reasons, but most companies are doing buybacks for the right reasons. The key to leveraging buyback announcements for investing is finding large, recent announcements done for the right reasons.
Exhibit 1: The data do not suggest some dramatic increase in shareholder payouts relative to R&D-adjusted net income.
Exhibit 2: Net shareholder payouts averaged approximately one third of R&D-adjusted net income.
Exhibit 3: 2018 has only been an average year in terms of number of buyback announcements YTD as of 8/27/2018.