Is stock repurchase a good thing or a bad thing?

Cash-rich Apple (AAPL) has been repurchasing its stock in an attempt to increase the stock price and provide value to shareholders. This may also be seen by some as a sign that the tech giant views the potential return of its stock as a better investment in its funds, rather than reinvesting in its business.

Key points

  • Although stock repurchases can bring benefits, they have been questioned in recent years.
  • Over the past ten years, buybacks have increased substantially. Some companies want to take advantage of undervalued stocks, while others do so to artificially push up their stock prices.
  • Buybacks can help increase the value of stock options as part of many executive compensation packages.
  • However, repurchase plans are easier to implement than dividend plans.

It is difficult to argue with Apple’s strategy. Due to continued mass sales of iPhones, the technology giant’s share price has risen by more than 35% last year (as of September 2021). However, Apple is certainly not the norm on Wall Street. Analysts continue to raise the question: Is the company’s stock repurchase a good thing?

One of 4 choices

For companies with extra cash, there are basically four options:

  1. Companies can make capital expenditures or invest in their existing businesses in other ways.
  2. They can pay cash dividends to shareholders.
  3. They can buy another company or business unit.
  4. They can use the money to repurchase their stock-stock repurchase.

Similar to dividends, stock repurchases are a way of returning capital to shareholders. Dividends are actually cash dividends, equivalent to a certain percentage of the shareholder’s total stock value; however, stock repurchases require shareholders to hand over stocks to the company to obtain cash. These stocks are then withdrawn from the circulation market and withdrawn from the market.

Repurchase country

Before 1980, buybacks were not common. Recently, they have become more frequent.According to the Harvard Business Review, between 2003 and 2012, 449 listed companies in the Standard & Poor’s 500 Index allocated US$2.4 trillion (approximately 54% of their earnings) for repurchase Report. Not only are giants like Apple and Amazon.com Inc. (AMZN), smaller companies are also participating in the buyback game.

In 2019, U.S. company stock repurchases totaled nearly 730 billion U.S. dollars. In the past decade, the company has been steadily increasing the amount of cash used to repurchase shares.

According to recent research by Harvard Business Review, more than half of corporate profits in the United States are used for stock repurchases. Some economists and investors believe that using excess cash to buy stocks on the open market is contrary to what companies should do, which is to reinvest to promote growth (and create jobs and capacity).

The biggest social concern for this has to do with opportunity cost-the funds allocated to shareholders in the stock repurchase program could have been used for maintenance and upkeep. On average, American fixed assets and consumer durables are now older than at any time since the Eisenhower era (1950s). The country’s crumbling roads and bridges have received a lot of attention, and private infrastructure has also been neglected-although few people talk about it.

The size and frequency of buybacks have become so important that even shareholders who may benefit from such corporate actions are not without concern.

BlackRock Chairman and CEO Lawrence Fink wrote: “We are worried that after the financial crisis, many companies have avoided investing in the company’s future growth. Too many companies have cut capital expenditures and even increased debt to increase dividends and Increase stock repurchase.”

According to the Harvard Business Review report, in 2012, the 500 highest paid executives listed in the proxy statement of US listed companies received an average of US$30.3 million each, 42% of which came from stock options and 41% from stock awards. Therefore, given the large positions in company stocks they usually hold and the amount they must acquire, the top executives have little incentive to reduce the size of their buybacks.

By increasing demand for the company’s stock, open market repurchases will automatically increase its stock price, even if only temporarily, and enable the company to reach its quarterly earnings per share (EPS) target. Nevertheless, repurchase can be done for completely legal and constructive reasons.

Benefits of share repurchase

The theory behind stock repurchases is that they reduce the number of stocks available in the market and—all things being equal—increase the earnings per share of the remaining stock, benefiting shareholders. For cash-rich companies, the prospect of increasing earnings per share may be tempting, especially in an environment where the average return on corporate cash investment is only slightly higher than 1%.

In addition, companies that buy back shares generally believe that:

  • The stock is undervalued, so buying at the current market price is a good choice. Billionaire investor Warren Buffett uses stock buybacks when he thinks the stock price of his company Berkshire Hathaway (BRK.A) is too low. However, the annual report emphasizes that Berkshire’s directors will only authorize buybacks at prices they believe. Far below Intrinsic Value.
  • Repurchase will create a certain degree of support for stocks, especially during periods of economic recession or market adjustment.
  • The repurchase will increase the stock price. Stock trading is partly based on the relationship between supply and demand, and a decrease in the number of outstanding shares usually leads to an increase in prices. Therefore, companies can create supply shocks through share repurchases, thereby increasing the value of their shares.

Buybacks can also be a way for a company to protect itself from a hostile takeover, or to indicate that the company plans to go private.

Some repurchase disadvantages

For many years, people believed that stock repurchases were a completely positive thing for shareholders. However, repurchase also has some disadvantages. One of the most important indicators for judging a company’s financial status is earnings per share. EPS divides the company’s total earnings by the number of outstanding shares; the larger the number, the better the financial situation.

By repurchasing shares, the company reduced the number of outstanding shares. Therefore, stock repurchases enable the company to increase this indicator without actually increasing its earnings or taking any measures to support the idea that its financial position is improving.

For example, consider a company with an annual income of 10 million U.S. dollars and 500,000 outstanding shares. So, this company’s earnings per share are $20. If it repurchases 100,000 shares of outstanding shares, its earnings per share will immediately increase to $25, even if its earnings have not changed. Investors who use earnings per share to measure financial conditions may think this company is stronger than similar companies with earnings per share of $20, but in fact using a buyback strategy can make up for the difference of $5.

The main reasons for repurchase disputes:

  • The impact on earnings per share may artificially boost stocks and obscure financial problems that can be discovered by carefully studying the company’s ratios.
  • The company will use repurchase as a way to allow executives to take advantage of stock option plans without diluting earnings per share.
  • Repurchase may cause a short-term rise in the stock price, which some people say will allow insiders to profit while attracting other investors. This price increase may seem good at first, but the positive impact is usually short-lived, and the balance will be restored when the market realizes that the company has not taken any measures to increase its actual value. Those who buy after the bumps may lose money.

Criticism of repurchase

Some companies buy back stocks to raise funds for reinvestment. All this is fine, until the money is not reinjected into the company. In July 2017, the Institute of New Economic Thinking published a paper entitled “The Financial Business Model of American Pharmaceuticals”, which discussed pharmaceutical companies and their stock repurchase and dividend strategies.

The study found that stock repurchases were not used to promote company development, and in many cases, the total amount of stock repurchases exceeded R&D expenditures. The report states:

In the name of “Maximization of Shareholder Value” (MSV), pharmaceutical companies distribute profits from high drug prices to large-scale repurchases or repurchases of their company stocks, with the sole purpose of manipulating stock prices. What incentivizes these buybacks is stock-based compensation, which rewards executives for the “performance” of stock prices.

And, as mentioned above, any boost to stock prices by buybacks seems to be short-lived. A large number of stock repurchases were carried out with Apple, Exxon Mobil and IBM. A CNBC article in May 2017 stated that since the turn of the century, Exxon Mobil’s total outstanding shares have fallen by 40%, while IBM’s has fallen by 60% from its 1995 peak. The article pointed out that this is not only in line with “financial engineering”, but it will also affect the overall stock index based on the weight of these companies.

Repurchase and dividends

As mentioned earlier, buybacks and dividends can be a way to distribute excess cash and compensate shareholders. If there is a choice, most investors will choose dividends over higher-value stocks; many people rely on regular dividends provided by dividends.

It is for this reason that the company may be cautious about establishing a dividend plan. Once shareholders get used to the dividend, it is difficult to stop or reduce the dividend-even if this may be the best approach. In other words, most profitable companies do pay dividends.

Buybacks do benefit all shareholders, because when they buy back stocks, shareholders can get market value, as well as the company’s premium. If the stock price subsequently rises, those who sell shares on the open market will see tangible benefits. Other shareholders who are not selling stocks now may see the price fall without realizing the gains when they finally sell the stocks at some point in the future.

Bottom line

Stock repurchase programs always have advantages and disadvantages for company management and shareholders. But as their frequency has increased in recent years, the actual value of stock repurchases has begun to be questioned. Some corporate financial analysts believe that companies use them as a hypocritical method to exaggerate certain financial ratios, such as earnings per share with the support of providing shareholder benefits. Stock buybacks also allow the company to exert upward pressure on the stock price by affecting a sudden decrease in supply.

Investors should not judge stocks solely based on the company’s repurchase plan, although it is worth looking at when considering investments. Companies that repurchase their stocks too aggressively are likely to be reckless in other respects, while companies that are only under the strictest circumstances (unreasonably low stock prices, stocks are not closely held) are more likely to allow shareholders to truly maximize The interests are at heart.

You should also remember to focus on the backbone of stable growth, use price as a reasonable multiple of revenue, and adaptability. In this way, you will have a better chance to participate in value creation instead of value extraction.

Some experts believe that the current high market level of repurchase will cause companies to pay excessively high prices for stocks, thereby appeasing major shareholders. For clients who invest in individual stocks, knowledgeable financial advisors can help analyze the long-term prospects of specific stocks, and can go beyond this short-term corporate behavior to realize the actual value of the company.

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