In response to a recent New York Times op-ed by Senators Schumer and Sanders deploring the effects of stock buybacks on workers and the economy, the authors explain the role of buybacks in increasing corporate productivity and in recycling “excess capital” from mature companies with limited growth and employment opportunities to the next generation of Apples and Amazons. Some companies, as Schumer and Sanders charge, are guilty of repurchasing shares in the name of “shareholder value maximization” instead of pursuing job-creating investments. But as the authors argue, well-run companies increase shareholder value not by boosting EPS through buybacks, but mainly by earning competitive returns on capital and investing in their long-run “earnings power.” And by paying out capital they have no productive uses for, such companies give their own shareholders the opportunity to reinvest in other companies with promising prospects for growth and jobs.
But the authors go on to note the tendency of companies to buy back shares not when their stock prices are low, but instead when the companies are flush with cash and nearer the top than the bottom of the business cycle. The result of this tendency, as research by Fortuna Advisors (the authors’ firm) shows, is that fully three quarters of companies doing large buybacks during the period 2013-2017 failed to produce an adequate “Buyback ROI,” a metric developed by Fortuna that indicates management’s effectiveness in “timing” its stock repurchases.
Given the usefulness of buybacks in recycling capital, the authors conclude that the most reliable solution to the corporate short termism and under investment problem is for companies to adopt better financial performance measures—including Buyback ROI—to guide their capital allocation. And when management determines that it has significantly more capital than value-adding investments, but wants to avoid committing to unsustainable dividend increases, it should consider buybacks—but only if management is convinced that it stock price has not outpaced performance.
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