While stock buybacks have gained momentum on Wall Street over the last five years, economists are becoming more and more cautious about the motives behind them.
Despite a slight decline in the third quarter of 2014, the number of buybacks for the trailing twelve-month grew 29 percent, according to FactSet, a financial data and research system. Its September report also pointed out that the decline in buybacks also compared well to the 0.5 percent decline in free cash flow. Still, companies with higher buyback rates have outperformed all other groups since 2005.
But William Lazonick, author of “Profits Without Prosperity,” a report recently published in the Harvard Business Review, said buybacks may raise stock prices in the short term, but they undermine income equality and job stability, and a company’s long-term growth prospects by its draining cash. It also reduces the amount of money a company has to pay workers, added Lazonick.
Buybacks, akin to dividends, are a common financial tool, enabling a company to buy back its own stock and returning cash to its shareholders. When a company buys back its shares from the marketplace, it reduces the number of its shares on the market, and should result in a higher share price.
In his recent report, Lazonick pointed out that buybacks tend to help the wealthy because they own the most stock. However, employees’ wages are growing very slowly. One reason executives buy back their companies’ shares, according to Lazonick, the buybacks mostly serve the interests of executives, much of whose compensation is in the form of stock.
“The trillions spent on buybacks over the last decade have had one primary purpose: to manipulate stock prices,” said Lazonick.
As a result, shareholders and investors should benefit from stock buybacks as long as the stock is below intrinsic value, said Todd Wenning, equity analyst at Morningstar Inc. If a company’s true value is $1, “a much better use of shareholder capital is buying back stock at 90 cents,” said Wenning, adding that if the company overpays for the stock, the value would not accrue to current shareholders but to people selling the shares.
“Ideally it’s management’s job to put their money where they get the best return for the money,” said Wenning, adding that saving the cash for future investment or expanding new plans are also plausible options.
Even Lazonick agrees not all buybacks are bad. For instance, Lazonick says tender offers, in which companies offer to buy back their shares at an agreed-on price, could help shareholders take advantage of a low stock price and free them from Wall Street pressure to maximize short-term profits. However, that’s not how most companies do buybacks. A large number of buybacks today are on the open market, which have no limit in price.
“GE spent $3.2 billion in 2008 on buybacks, paying an average price of $31 per share,” said Lazonick. “The company had to issue new shares at an average of $22 after the company was hit by financial crisis.”
Hurting shareholders, it seems, is part of the buyback game.