What's Behind the Share-Buyback Binge?

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The trend has been hard to miss. Chipmaker Intel (INTC) bought back a whopping $10 billion of its shares on Jan. 24. Drugmaker Pfizer (PFE) purchased $5 billion of its stock Feb 1, and media giant Time Warner (TX) followed suit with its own $5 billion buyback the next day.

Companies are on a stock-buyback binge that's reaching dramatic proportions. January alone saw $57 billion in buybacks, compared with a total $357 billion for all of 2010, says Vincent Deluard, executive vice president of New York-based TrimTabs Investment Research, which tracks share buybacks. Deluard says the 2010 number was up 174% from 2009.

Dealing With Cash Flow

What's behind the surge? According to Tim Koller, a partner at consultants McKinsey & Co. and co-author of a new book called Value: The Four Cornerstones of Corporate Finance, many big firms accumulated a huge amount of cash during the financial crisis and were reluctant to spend it.

"They not only have to deal with the cash flows they're generating now," he says, "but they also have to somehow distribute the cash they generated during the crisis that they didn't distribute."

And it's not as if they aren't spending money at the same time, too. Intel bought McAfee for $7.6 billion last August.

Robert Schwartz, a finance professor at Baruch College in New York, says the decision to repurchase shares generally is "an information signal that the stock rise is unduly low and it's a good deal."

What's In It for Investors?

Generally speaking, analysts believe investors should make out the same -- whether a company pays the cash as a dividend or uses it to buy back shares. With a stock buyback, there's a mechanical effect that causes the remaining shares to rise by the amount of the repurchase.

"Companies have shifted from dividends to using share repurchases to distribute cash to shareholders," Koller says. "The reality is successful companies, once they mature, will generate a lot more cash flow than they can invest. Companies are not comfortable paying 70% to 80% of the earnings as dividends."

In addition, some large institutional investors prefer buybacks to dividends because they don't have to decide what to do with the extra money.

For the small investor, a buyback often offers more options. It means they don't have to take the benefit right away, as they do with a dividend, and pay tax on it. Long-term capital gains also pay less tax than dividends.

Koller notes that sometimes investors are concerned about what companies will do with all the excess cash they generate. "They're concerned the companies will invest it unprofitably or make acquisitions that aren't successful," he says. "In that sense, buybacks provide some confidence to investors who feel that is what the companies need to do – return that cash flow."

Mounds of Cash Sitting Overseas

Academic studies, Koller says, show companies that regularly buy back shares don't increase value any faster than companies that don't. So don't count on a newly announced buyback to send a stock higher over time. It's the company's operations that determine that.

Considering the estimated $1 trillion in cash idling on the balance sheets of S&P 500 companies, why hasn't that cash been given back? According to Koller, much of that money is sitting overseas -- and firms would face prohibitive tax bills if they brought it back to the U.S. With talk in Congress now of reforming the corporate tax structure, many businesses are waiting to see what the lawmaker come up with before bringing the money back and paying it out to investors.


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Dereck

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May 29 2011 at 1:24 AM Report abuse rate up rate down Reply
Ellis

In my honest opinion, the share buy-backs programs are on the verge of disastrous collapse. Not only does it inflate the true value of the stock, but, to me, it represents a concern that the company management feels that the company cannot sustain a "bear" market. Similar to a "run" on a bank where more monies are withdrawn than deposited. A"bear" market would constitute the investors concern on the stability of their shares, causing a "panic run" of selling, not buying. If you would do the research, similar programs have been used to protect the upper echelon of investors just before panics have decimated the average investor. I feel this is the start of a bigger "bubble burst" than the one that occurred in October, 1929.

February 14 2011 at 6:36 AM Report abuse rate up rate down Reply
Ellis

In my honest opinion, the share buy-backs programs are on the verge of disastrous collapse. Not only does it inflate the true value of the stock, but, to me, it represents a concern that the company management feels that the company cannot sustain a "bear" market. Similar to a "run" on a bank where more monies are withdrawn than deposited. A"bear" market would constitute the investors concern on the stability of their shares, causing a "panic run" of selling, not buying. If you would do the research, similar programs have been used to protect the upper echelon of investors just before panics have decimated the average investor. I feel this is the start of a bigger "bubble burst" than the one that occurred in October, 1929.

February 14 2011 at 6:36 AM Report abuse +1 rate up rate down Reply
Carolyn

I'M HAVING A RATHER DIFFICULT TIME TRYING TO BUY 19 SHARES OF PRUDENTIAL STOCK. I CAN'T SEEM TO FIND ANYONE IN THE COMPANY THAT WILL HELP ME.

THEY SEEM TO REFER ME TO 'COMPUTERSHARE' WHO'S INFORMED ME THAT THEY DO NOT SELL PRUDENTIAL STOCK; THUS, I REALLY DON'T KNOW WHERE TO TURN. PLEASE KNOW THAT I AM AWARE THAT 'COMPUTERSHARE' DOES HANDLE PRUDENTIAL STOCK, BUT ONLY TO 'BUY BACK' SHARES AND NOT TO SELL THEM.

February 13 2011 at 9:57 PM Report abuse rate up rate down Reply
mansobravo

Stock buybacks benefit management. They hide the effect of awarding stock options that would otherwise increase the number of outstanding shares. It's a way to manipulate share prices, and not in the interest of retail investors.

February 13 2011 at 1:45 PM Report abuse +1 rate up rate down Reply
syhersch

The function of most companies is to put together a product, sell the product and deliver profit to its shareholders. The basic problem with buybacks is that basic function is not being addressed. It is not management's job to manipulate stock prices with the proceeds from its products' profits. Those profits should be directly distributed after reserving some for future growth to its shareholders. Instead buybacks function to theoretically increase share prices for no other reason other than the company using its profits to buy its stock. I might add that this is the theory, not necessarily the reality. As far as the tax inefficiency of dividends, for the average investor they are anything but inefficient. Moreover if the dividends are going to other corporations the tax efficiency is even greater. One of the less obvious consequences of share buybacks is that very often those purchases are done in private purchases making it a potential source of backroom dealings which may utimately be harmful to the greater body of shareholders.

February 12 2011 at 6:41 PM Report abuse +2 rate up rate down Reply
adrianm917

I am always fascinated by discussions on stock buyback as if they are magical. If a stock is cheap, then a buyback is a good use of capital and if it isn't then they shouldn't be buying in stock and you should probably not own that stock. Dividends are tax inefficient vs. buybacks as you have to pay taxes on the dividends and not on the buybacks. The reality is that people prefer dividends so dividend paying stocks tend to trade at higher multiples. This is irrational in some ways as dividends are not as tax efficient but it is logical in many ways due to the fact corporations can't waste cash they are committed to paying out. In summary, if you own a company that you think is trading very cheaply, you should hope for lots of stock buybacks! - Adrian Meli

February 12 2011 at 6:17 PM Report abuse rate up rate down Reply
hnnrobe

As alluded to by others,this article is totally biased and unfounded.While some monies should be withheld from shareholders to allow corporate adaptations in the future,judicious dividends should be the norm.The share buyback trend is undeniably a way to drive up share prices, and thus, transfer the large cash holdings to management, who hold shares and purchase options.This is a significant factor why this is a jobless recovery, and why economic power in this country is waning.

February 12 2011 at 4:34 PM Report abuse rate up rate down Reply
hnnrobe

As alluded to by others,this article is totally biased and unfounded.While some monies should be withheld from shareholders to allow corporate adaptations in the future,judicious dividends should be the norm.The share buyback trend is undeniably a way to drive up share prices, and thus, transfer the large cash holdings to management, who hold shares and purchase options.This is a significant factor why this is a jobless recovery, and why economic power in this country is waning.

February 12 2011 at 4:34 PM Report abuse rate up rate down Reply
bfpowersjr

Mr. Wallace: I wonder if management might be thinking about their Employee Stock Options when they authorize buybacks(?).

February 12 2011 at 12:12 PM Report abuse rate up rate down Reply