The big share buyback controversy

US politicians have share buybacks in their sights. They may be right to do so, says John Stepek – but not for the reason they think.

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Rubio aims to change buyback tax laws

2018 Getty Images

Share buybacks have always been controversial, but now they are rapidly turning into US public enemy number one. Last year, a record $1trn was earmarked by companies to buy their own stock, boosted by the $700bn or so that US companies brought back onshore after tax rates on repatriated profits were slashed. Politicians of all stripes have argued that this money should have been spent on boosting wages or investing in expansion. Republican senator Marco Rubio wants to change tax laws to make buybacks less appealing, while various Democrats have argued that buybacks are mainly aimed at boosting executive bonuses. So what's the fuss, and does it matter for investors?

The idea that executives use buybacks as an easy way to boost earnings per share (EPS) is a common objection. As far as 2018 goes, investment bank Goldman Sachs says this is unfair. The pay packets of bosses in around half of the companies in America's S&P 500 stock index are linked to EPS. Yet last year, these firms spent a smaller proportion of cash on buybacks than their peers, notes Goldman, and spent more on dividends. Now, no one will be amazed at Goldman defending executive pay, and other longer-term studies suggest that the complaints about executive pay do have weight.

However, the real issue for investors, says Richard Teitelbaum in Institutional Investor, is that companies are like most of us for all that they should be best-placed to understand the value of their firm, they are not very good at market timing. As Warren Buffett whose investment vehicle Berkshire Hathaway has strict criteria for buying back its own shares puts it: "Obviously, repurchases should be price sensitive. Blindly buying an overpriced stock is value-destructive, a fact lost on many promotional or ever-optimistic CEOs." Yet, as Teitelbaum points out, buybacks peaked in both 2000 and 2007 (significant market highs), and collapsed in 2009 which, of course, would have been the best time to hoover up as much stock as possible.

While we tend to prefer dividends (see below for why), there's no need to sell or avoid a company just because it engages in share buybacks. Indeed, it can be a positive sign Japanese companies, notoriously loath to return cash to shareholders, are starting to do so via buybacks, which bodes well for the future appeal of Japanese stocks, notes Richard Aston of the CC Japan Income & Growth Trust in What Investment. However, the clarity (or otherwise) of a buyback scheme can give you an idea of whether management is more concerned about getting shareholders value for money or boosting their own pay packets.

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