What Investors Need to Know About Stock Buybacks

Stock buybacks are deceptively complex. (Perhaps this mystery adds to their allure among CFOs!) Shareholders should be particularly concerned because a recent report suggests that buyback confusion also extends to the board room.

Ever since the SEC loosened its regulation on buybacks, companies have been changing the way they distribute cash to shareholders. By McKinsey’s calculations, share buybacks have increased to about 47 percent of the market’s income since 2011, up from both about 23 percent in the early 1990s and less than 10 percent in the early 1980s.

A recent report¹ sponsored by the IRRC Institute, highlights interviews with 44 directors serving on the boards of 95 publicly traded U.S. companies and their perspectives on stock buybacks. One concerning conclusion from this report is that directors may view share buybacks as a method of covering up the unfavorable aspects of stock options.

The report’s author, Richard Fields, shared that he was struck by how universally accepted the assumption is that equity compensation should be offset by buybacks. For example, one director reported, “I believe you always buy stock back to offset dilution that comes from granting options. You do not want to dilute the current shareholders.”

Wait—hold on. This is terrible reasoning. Buybacks don’t offset the dilution of share value (caused by granting options). Assume with me that ACME Corp. has two shares of stock before awarding its CEO one share of stock as a reward for hitting growth targets. In our overly simplified example, adding an additional share increases the total outstanding shares to 3 and reduces the value of each existing share 33%.

Here’s how buybacks work. Now assume that ACME Corp’s market value is $300 and the corporation uses excess cash to purchase one of the existing shares with the aim of destroying this share and reducing its overall shareholder count. After the repurchase is complete, there are two remaining shareholders and the corporation is worth $200 (after $100 was distributed). In this example, the remaining investors are no better or worse off than before the buyback. They still own one share of stock and each share retains its original $100 value. The purpose of the buyback is to enable ACME to slim down by distributing cash that’s not being put to productive use.

stock option and buyback

Equity compensation is a very effective tool, but it’s naive to believe that buybacks can shelter shareholders from its costs. Another director quoted in the IRRC study shared this: “If we are using hard dollars to offset stock dilution, we should treat those hard dollars as a compensation expense. Otherwise we are not recognizing what we are actually spending to compensate our people.”

Corporations have many good reasons to pursue an equity buyback strategy, but camouflaging executive pay isn’t one of them.

¹Buybacks and the board: Director perspectives on the share repurchase revolution

Senator Mark Warner Sees Market “Renters” and We Need “Owners”

warnerPolitifact found that Sen. Mark Warner’s comment that average stock holding periods have changed from over 8 years in 1960s to 4 months currently is “Mostly True.” After looking at NYSE data, it is a bit more accurate to say that the holding period during the 50s and 60s was closer to 6 years and today’s estimates come in around 6 months.

So what’s the big deal? Senator Mark Warner points out a related trend: Corporations now invest little of their profits back into their company. During the 50’s and 60’s, the reinvestment rate was closer to 50% and now 95% of profits go to dividends and an unhealthy infatuation with stock buybacks that also happen to boost executive bonus payouts.

It’s hard to convince management to focus on the long term when their owners are suffering with a bad case of short-termism. <cough, cough>

 

Photo by Alex Guillaume on Unsplash

10 Virginia Companies Make Fortune’s 100 Best Companies To Work

High trust culture isn’t just a feel-good perk. Great Places to Work reports that decades of research shows workplaces with high-trust cultures see higher levels of innovation, customer and patient satisfaction, employee engagement, organizational agility, and offer higher shareholder returns to investors. Great Places To Work teamed up with Fortune to recognize superior American companies. Here is the list of Virginia-headquartered companies who made the list:

#12: KPMG
#17: Capital One
#23: PwC
#26: Hilton
#29: Ernst & Young
#47: Navy Federal Credit Union
#50: Mars, Incorporated
#74: Rackspace
#77: Carmax
#88: Accenture

You can see Fortune’s entire list of 100 companies here.

Small and mid-sized Virginia companies (15 – 1000 employees) looking to assess their own employee culture should look to a free service. This “Best Places To Work In Virginia” survey is sponsored by the Virginia Chamber.

All of this analysis around trust is especially important during a time when the 2017 Edleman Trust Barometer reveals that trust is in crisis around the world.

10 Signs that SRI Investing is Hitting a Tipping Point

  1. US Trust study finds 85% of millennials want to invest with purpose.

  2. The US Sustainable Investment Forum reports 33% growth in SRI strategies in two years’ time from 2014 to 2016.

  3. The same report suggests that SRI filters apply to just under 20% of US equity assets, but there’s good reason to believe that we’re still in the early innings of this ballgame. For comparison, Bank of America Merrill Lynch report suggests that in Europe, SRI allocations are closer to 60%.

  4. GA Institute reports that the percent of S&P 500 companies publishing a sustainability report has gone from 20% to 82% between 2011 and 2016.

  5. Impact Investing is the “top trend” in philanthropy for 2015 and 2016.

  6. The Ford Foundation committed $1 billion to mission-related investments.

  7. Japan’s Government Investment Fund recently allocated 1 trillion yen ($8.9 billion) to socially responsible investments. Ho-hum say the Norwegians, the world’s largest sovereign wealth fund instituted their ethical guidelines in 2004.

  8. America’s largest asset owners, including Blackrock and even sleepy Vanguard, are stepping up their commitments to shareholder advocacy on ESG issues.

  9. The Department of Labor now has clear guidance that ESG can and should be considered in employer sponsored retirement plans.

  10. The Pope is now talking about impact investing.