I had an interesting break room conversation about share buybacks. The conversation was in the context of impact of share price and need to provide a down side support. I thought it would be worthwhile to look at it from the dividend investing perspective.
The business media purports a notion that companies engage in share buybacks to support the down side of their share price. This is good because it returns back some of the cash flow and helps the shareholders. So let us look at some hard facts:
As per Standard and Poor’s research published in December 2007, S&P500 index companies spent (three years preceding the published date):
- USD 1.318 trillion on share buybacks;
- USD 1.276 trillion on capital expenditures;
- USD 0.376 trillion on research and development; and
- USD 0.605 trillion on common dividends.
To put these numbers in perspective, the entire market capitalization of the S&P 500 was approximately $14 trillion around that time frame. I was under the impression that corporate America spends more in research and development. However, this observation tells me otherwise. No wonder there is a pattern of lack of innovation. Anyways continuing on our subject…
The share buyback was the highest expenditure while the dividend comes last. Dividends are approximately half the value of share buybacks. But aren’t share buybacks actually returning value to the shareholders? If that’s the case, why are companies not on buying binges in this market environment? The current environment provides the best buying opportunity for their stock. Shareholders need downward support “now”. Instead, companies are saying they are preserving cash. Why didn’t they preserve cash when they had piles of it? The Standard and Poor’s research report made an interesting observation which is as follows:
Traditionally, companies have used buybacks to offset the issuance of employee options, M&A activity, to temporarily support their stock and to reduce their share count. Over the past decade the option portion has accounted for the major use of repurchased shares and actual share reductions the least. Companies usually highlight and lump these expenditures, along with dividends, and present them as a return to investors of shareholder value.
The majority of buybacks are to offset the share count change due to exercise of options by the managements and employees. Typically, the majority of the options are held by management and executive teams, while employees have a minuscule percentage. Buying back stock provides support and helps keep prices at higher levels, so that management gets higher value for their options. This is an indirect way to pay themselves.
In addition, the reduction in share count helps increase the EPS quarter after quarter (assuming controlled buying through out the year). Disciplined Investing posted an article with some good examples for 3M (MMM), BUD, and ADP. Here, let us look at PEP, INTC, and GE.
I am guessing PEP, INTC, GE just bought back shares to offset the options exercised by management and employees. This is an indirect way to transferring profits back in the pockets for management (and to lesser extent employees).
My take on this issue….
I do not have any particular dislike for share buybacks if they are supported by management’s true intent and honest communication. However, above examples show that there seems to be a “missing fine print” which is not being communicated to the shareholders. It appears that management is more intent towards balancing the options pricing needs (rather than shareholder interests). The misrepresentation and incorrect intent of share buyback is what I do not like.
Disclosure: Long INTC, GE.