Why Do Corporations Buy Back Their Shares?
Since the advent of Quantitative Easing we have witnessed unprecedented levels of stock buybacks by US Corporations. Buyback volumes have surpassed $1 Trillion in five short years as corporate executives have been forced by financialization of the economy to flock to a buyback strategy.
Why the dramatic shift?
- Corporations have been experiencing top-line global revenue pressures and constraints for existing products since the Financial Crisis,
- They face excess corporate capacity and under-utilization while confronting a mounting global supply glut due to cheap global money and ready credit for all competitors,
- They see preferential tax treatment for increasing debt and leverage.
During times of low interest rates it is sound strategy to increase corporate leverage, as long as the debt is employed judiciously so that the incurred debt can be safely handled when rates eventually and often unexpectedly go up. Unfortunately, what is occurring is that debt is not being invested into productive wealth generating assets but rather into reducing the equity capitalization of the corporation. There are potentially major longer term economic, political and financial ramifications from this occurring.
By buying back shares, corporations blatantly promote better EPS (Earning per Share) for the same or falling earnings. This Wall Street-welcomed superficial ‘sleight of hand’ often has the effect of driving up share prices, which is the critical “currency” of the modern corporation that they employ for both acquisitions and maybe more importantly for protection from takeover raiders.
It’s About Dividend Payout versus Dividend Growth
A critical element of corporate rationalization for the strategy adoption few investors appreciate is actually about the reduction of the cumulative amount of dividend payout while showing the dividend payout percent to be increasing on a per share basis. In a world starved for yield with over 70% of global bonds with negative yields, and almost all global bonds paying negative real bond yields, this can make US equities very attractive to global yield investors. The best performing Dow Industrial stocks have consistently been those with attractive dividend payouts. Through the use of complex derivative strategies, dividends are often economically stripped out by clever financial institutions so they have no exposure to the underlying equity price.
