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What are Stock Buybacks? (Updated 2023)

Stock buybacks on a global level reached a record US$1.31 trillion in 2022, nearly on par with dividend payouts. New investors might be wondering: What are buybacks? What do they entail, and why are they important?

A stock buyback occurs when a company repurchases outstanding shares in order to reduce the number of shares it has on the stock market. Companies can take this step as a way to increase the value of available shares through reducing supply; they might also go this route as a way of decreasing the possibility of shareholders taking a controlling stake in the company.

To put it another way, a buyback is a way for a company to invest in itself. When a buyback happens, shareholders may receive an offer that gives them the option to submit a portion or all of their shares for reimbursement at a premium to the current market price. Alternatively, the company may buy back its own shares on the open market over time.

Between 2015 and 2019, companies reinvested capital through stock buyback programs at a compound annual growth rate of 10.4 percent, with buybacks totaling more than US$3 trillion in that five year period. Nearly half of that figure was attributed to spiking levels of stock buybacks over the last two years investigated, including a record US$770 billion in 2018.

In 2020, the market experienced a slowdown in stock buybacks brought on by the COVID-19 pandemic. Not only did stock buybacks become politically unpalatable in this time of crisis, but as part of American COVID-19 relief legislation, corporations receiving federal aid were banned from buying back their own shares until a year after their government loans were paid back.

The New York Times reported in March 2020 that companies such as AT&T (NYSE:T) and McDonald’s (NYSE:MCD) had suspended their stock buyback programs. What’s more, even though they are often the biggest buyers of their own stock, some of the big banks stopped buying back shares as well, including JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C).

However, not everyone bailed on buybacks during the pandemic. Apple (NASDAQ:AAPL), the top share repurchasing company, bought back US$16 billion of its stock in Q2 2020, although that was 6 percent lower than the comparable 2019 period.

According to Forbes, in 2021 several major companies instituted large stock buyback programs and increased dividend payouts, demonstrating optimism about the post-COVID-19 economy and a desire to reward shareholders. These firms included Advanced Micro Devices (NASDAQ:AMD), Nucor (NYSE:NUE) and Berkshire Hathaway (NYSE:BRK.A,NYSE:BRK.B). In late 2021, Microsoft (NASDAQ:MSFT) authorized an increase in its total buyback program, raising it from US$40 billion to US$60 billion.

Much of the growth that caused 2022’s record US$1.31 trillion in stock buybacks was attributed to oil companies, according to data from Janus Henderson Investors. ‘By far the biggest contributor to growth in 2022 came from the oil sector, in which companies bought back $135bn of their own shares, more than four times as much as 2021,’ explains the asset management firm. ‘Almost all this oil-sector cash was spent by companies in North America, the UK and to a lesser extent Europe.’

So far in 2023, stock buybacks look set to surpass the trillion-dollar mark again, and may even top last year’s record high.

Are stock buybacks good for investors?

Stock buybacks can be appealing to investors in a handful of different scenarios. In one common instance, they can be a signal that a company has excess cash on hand, giving shareholders reassurance with regard to the company’s cashflow status.

‘For starters, they’re a sign that the company won’t be doing something wasteful with that excess cash — like making an unwise acquisition or expanding too rapidly — and some investors feel they’re a good sign overall,’ Capital Asset Management President and CEO John E. Girouard wrote in an article for Forbes.

‘For example, many investors’ first instinct on buybacks is, ‘Oh, this company must know something good is about to happen, and thus they want more profit for themselves.”

Alongside the idea that good things are to come is the share price boost that buybacks can provide. If a company feels its shares are undervalued, it may buy them back and then resell them in the open market after it sees a share price improvement. This type of improvement is generally the result of simple supply and demand.

Can stock buybacks have a negative impact?

As with most things, there is a dark side to stock buybacks. Critics point out that the excess cash used to buy back shares should actually be reinvested to facilitate job creation and infrastructure upgrades.

Investopedia has identified three negative impacts of stock buybacks:

They can “give an artificial lift to the stock and mask financial problems.’They allow executives to take advantage of stock option programs while not diluting earnings per share.They can create a short-term share price bump that may allow insiders to profit at the expense of investors.

Dryden Pence, chief investment officer of Pence Wealth Management, told Forbes that stock buybacks can also be harmful to companies because they can hamper their ability to ride out a financial storm.

Citing airlines as an example, Pence said that over the last decade, major US airlines spent 96 percent of their free cashflow on buybacks, hence why these same airlines needed US$54 billion in government bailouts during the COVID-19 crisis.

The potential negative impact on the economy as a whole prompted Democrats in the US to include a 2 percent excise tax on stock buybacks as part of the corporate tax proposals included in the country’s 2022 budget bill. A survey conducted by the CNBC Global CFO Council indicated that 55 percent of US CFOs believed such a tax would curtail their buyback activities.

The 2 percent excise tax proposal eventually died along with the Build Back Better Plan. A 1 percent excise tax was later included Biden’s Inflation Reduction Act, which took effect in 2023.

What questions to ask when a stock buyback occurs?

When a company institutes a buyback program, shareholders should ask themselves why it is occurring. Is the company changing direction? Does it need to increase its earnings per share? Is a share repurchase a way to regain equity, and therefore control?

It’s important to consider these questions, as the answers can determine whether it is prudent to hold on to a stock, or whether it’s better to take the buyback being offered. Share buybacks can also give insight into how a company is functioning overall, which is important when making investment decisions in general and can help when getting a feel for a company’s industry and field.

In any case, investors should weigh all options and driving factors in order to make the best decision when a buyback is offered.

Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.

This post appeared first on investingnews.com

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