The old stock buyback myth.
You’ve probably heard it before. After all, corporations love to tell you that stock buybacks are their way of rewarding you, their loyal investor.
But more often than not, stock buybacks are just a way for companies’ head honchos to line their own pockets.
As a former Wall Street insider, I’ve seen this controversial practice with my own eyes.
In my senior management roles at Bear Stearns and Goldman Sachs, a good chunk of our compensation did not come in cash, but in stock options.
What that meant was that every time a share buyback was done (which elevated share prices), the value of those options rose–meaning compensation increased after it was paid out.
That’s sort of like having an inflatable paycheck. Some of my colleagues would muse about what kind of “Lambo” or “beachfront” they could buy with just that difference.
But today, we’re turning the tables on Wall Street. I’m going to spill one of its biggest secrets… And show you how to turn it into an opportunity for you in today’s rocky markets.
Stock Buybacks Are in Overdrive
Now, stock buybacks aren’t new. But the volume has gone into overdrive during this era of turbo-boosted central bank policy.
In the U.S., stock buybacks helped ignite the Great Stock Market Crash of 1929 that spawned the Great Depression.
They were outlawed by the Securities Exchange Act in 1934 as one way to level the playing field of Wall Street vs. smaller investors.
That was because they enabled corporate bigwigs to boost their share prices without having to upgrade their business strategy – or even produce higher profits or greater efficiency.
Certain bankers during the 1920s used their company’s funds to buy their own stock, and then sold it at higher levels to other investors, making a killing while other people were left holding the bag.
For more than half a century, stock buybacks were considered an illegal manipulation of the stock market… until 1982, when they were legalized if contained to 25% of a company’s book.
Since the financial crisis, in particular, stock buybacks re-emerged as a main tool of large companies to not only raise their share prices… but to garner attention from investors and speculators and amplify the effect.
Some of these firms also increased their debt loads because they borrowed at low rates, and diverted that money into their share prices rather than using cash on hand. That’s one reason why government and corporate debts are at record highs.
What the pandemic revealed was that certain companies – such as Boeing and American Airlines, which had pumped money into shares rather than saving it for an emergency – had to use government assistance to get by.
No one could have forecast the pandemic or how massive the ensuing economic shutdown would be. But these companies, in an era of overwhelmingly cheap money, chose not to set money aside for a rainy day… and wound-up costing taxpayers in the end.
Now, markets don’t care where the money comes from. As long as the money keeps coming in, they’re happy.
These actions lifted markets upward, especially stock markets. Without that extra money flow, stock markets would simply not be as high as they are now.
The main problem with stock buybacks bought with cheap central bank money is that they enforce a distorted picture of a company’s true financial health.
And today, we may be seeing the effects of these distortions finally come back to bite.
The S&P 500 has fallen by about 12%. That means it’s officially in correction territory. And if you’ve got money in the markets, you may be worried.
But there is a silver lining for you in Wall Street’s buyback scheme.
That’s because buybacks still attract money to the associated shares, which leads to rising share prices. And despite the carnage we’re seeing in the markets today, I believe we’ll see the positive effects of buybacks again soon.
The volume of buybacks dropped dramatically during the first half of 2020 because of the pandemic. This happened out of sheer fear. Companies realized that keeping money in the corporate cookie jar was a prudent thing to do.
Since then, the volume of buybacks has ballooned six quarters in a row. And total buyback volume has made new records.
The total buyback volume for 2021 was nearly $850 billion. The prior record was $806 billion in 2018.
As it turned out, just five firms accounted for nearly 30% of the buybacks in the third quarter of 2021. Four were technology companies, the other was Bank of America.
Apple purchased $20.4 billion of its own shares, Meta Platforms (formerly Facebook) bought $15 billion, Alphabet (Google) bought $12.6 billion, Oracle bought $8.8 billion, and Bank of America bought $9.9 billion worth of their own shares.
What This Means for Wall Street – and Your Money
What does this mean for you today?
The short answer is that Wall Street has been lying to you for years.
Companies like to tell us that buybacks benefit us, not them. I’m sure you’ve heard this before. But in many cases, it’s simply not true.
If CEOs and other people in management didn’t get inflated paychecks because of stock buybacks, they wouldn’t be as keen on them.
As I mentioned, I saw this during my time on Wall Street – and that was even when the size of buybacks was worth in the millions, not billions, of dollars.
Companies tell us that buybacks reduce the overall share count. And that, they claim, makes each of the shares we hold more valuable.
But that’s not always true.
Often, companies buy back their shares just as a big-shot executive there is cashing out his or her options. That amounts to a wash on the number of outstanding shares, which doesn’t help investors.
But here’s the good news for you. Despite this distorted lay of the land, there are companies that do reduce their share count through buybacks, and thus increase their earnings per share numbers in the process.
That includes some mega tech companies.
Now, as I wrote about last Monday, tech stocks have been some of the hardest hit so far this year. But coming buybacks could help ease some of the losses we’re seeing…
And, in fact, the way Wall Street and corporations operate, they have cash set aside for just this sort of buyback opportunity.
As I also mentioned last week, corporate earnings are expected to rise in 2022. That means more money coming in. And that tells me that buybacks will hit another record in 2022…
Especially when you combine that with the cheap money still oozing out from central banks.
So if you’re already invested in the markets, wondering when the selling is going to stop, I recommend you hang tight.
I don’t expect the red streak to last much longer. There is still plenty of available cheap money around – from central banks and company insiders alike – to buoy the markets.
If, on the other hand, you have some extra cash to deploy, you can look into the Invesco BuyBack Achievers ETF(PKW). It tracks the 100 stocks with the highest buyback ratios.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins
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