Backing buybacks

Edward Luce’s recent front page piece in the FT (The short-sighted US buyback boom) pretty well echoes the recent bashing against buybacks and villain executives and directors.

(…) At a time of soaring profitability, US companies have piled up huge amounts of cash, much of it parked offshore. Yet investing it in long-term growth is the last thing on their mind. According to Barclays, US companies have lavished more than $500bn in the past year on stock buybacks – a multiple of what most are spending on research and development and other capital investments. In the first six months of the year, buybacks surged to $338.3bn – the largest half-yearly volume since 2007. The rationale is simple. By reducing the volume of outstanding shares, chief executive officers increase earnings per share. That in turn lifts their pay, which is heavily tied to short-term stock performance. If you need an explanation for why the top 0.1 per cent is doing so well, start with equity-based compensation.

But the impact is much broader than that. According to William Lazonick, a scholar at the University of Massachusetts Lowell, seven of the top 10 largest share repurchasers spent more on buybacks and dividends than their entire net income between 2003 and 2012. In the case of Hewlett-Packard, which spent $73bn, it was almost double its profits. For ExxonMobil, which came top with $287bn in buybacks and dividends, it amounted to 83 per cent of net income. Others, such as Microsoft (125 per cent), Cisco (121 per cent) and Intel (109 per cent) were even more extravagant. In total, the top 449 companies in the S&P 500 spent $2.4tn – or more than half their profits – on buybacks in those years. They spent almost the same again in dividend payouts. Taken together, they came to 91 per cent of net income. (…)

In the past week, consumers have gone wild over the launch of the iPhone 6. It is US innovation at its best. Will Apple still be at the cutting edge a decade from now? Not if you judge by what it does with its cash. The company keeps tens of billions of dollars offshore to avoid paying US corporate taxes. Yet it borrows at home – including a record $17bn bond issue last year – to fund a massive share buyback spree (Apple spends more on equity repurchases than any other US company). The roots of the problem lie with poor governance regulations and a badly outdated tax system. Unless these are fixed, boardrooms will keep on draining their treasuries at the expense of other stakeholders. Greed will always be with us. Dumb laws are optional.

Let’s look at the facts.

The following chart plots the proxy for the S&P 500 Index share count since 1990:

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