Corporate America’s share buyback binge
American companies have been busy buying up their own shares - investors should take note.
Investors take note, says The Economist. American companies have been buying back their shares at a near-record pace, spending $500bn in the past 12 months.
Exxon has spent $200bn on its shares, enough to buy BP; IBM is spending twice as much on share repurchases as on research and development.
Buybacks are often seen as a sign that a stock is good value, but in truth "executives are hopeless" at gauging whether their shares are attractively valued or not.
Some companies are borrowing too much to pay for buybacks. Interest paid on debt is tax-deductible, but interest earned on cash is taxable. So a company cuts its tax bill if it borrows to fund buybacks.
Last year, 38% of firms "paid more in buybacks than their cash flows could support, an unsustainable position".
Moreover, managers whose pay depends on earnings-per-share targets are often tempted by buybacks: by reducing the number of shares outstanding, they give earnings per share a boost.
All this means that firms are tempted to overdo buybacks at the expense of investment, which will undermine their long-term prospects.
As it happens, there are now signs that record-low interest rates are finally prompting companies to ease up on buybacks and start investing. But that means a key driver of strong recent earnings-per-share growth will weaken.