About a year ago, I addressed the controversial practice of corporate share buybacks.
I noted that companies using cheap money – or even excess cash lying around their books – to purchase their own shares could distort the true value of those shares upward.
And despite the Fed’s rate hikes making the cost of borrowing more expensive and increasing market uncertainty, corporate America has kept up its buying spree – of its own shares.
In fact, last year, American companies announced a record $1.26 trillion of share buybacks. That figure was up 3% from 2021.
During January of 2023 alone, the total amount of stock buybacks was more than triple the amount in January 2022, or $132 billion. That figure is the highest total to start a year.
Morgan Stanley’s buyback execution desk has already seen a 5% increase in orders for 2023.
And last Tuesday, in his State of the Union address, President Joe Biden announced his plans to impose a 4% tax on this practice.
So today, I’ll discuss why the increase in buybacks is important for your money, and if Biden’s speech is any cause for concern…
Buybacks Lift Stock Market Values
First, let’s take a step back and review what buybacks are.
A share buyback occurs when a company purchases its own outstanding shares from the market. As a result, its remaining outstanding shares could have more comparative value to investors.
It’s a simple demand versus supply equation. Let me explain why.
As companies reduce the amount of their shares outstanding, they can push the value of the remaining shares outstanding higher. That’s because they are acting as a source of demand for their own shares, then taking them out of market circulation, thereby reducing their supply.
That means the earnings per share grow automatically higher, because total earnings are divided by a smaller number of shares.
It’s a corporate price distortion mechanism. The company hasn’t necessarily become more valuable, it just appears that way.
But there’s a plus side.
This practice of reducing the amount of shares in circulation can render existing shareholders’ securities in the company more valuable and the dividend paid per share higher, too.
That’s why paying close attention to which companies are buying back shares could translate into a big buying opportunity for you…
Who’s Buying Back Shares? (Hint: Everyone)
Traditionally, the big tech and banking sectors have been the most aggressive sectors in terms of share buybacks. And we are seeing that shape up again this year.
Facebook’s parent Meta Platforms (Meta) stock put in its best stock performance about a decade after the firm announced a $40 billion buyback program. Its share price jumped by 23%.
This announcement marked a 43% increase over its 2022 stock buybacks of $28 billion. The last time its shares jumped as high so quickly was in July 2013.
Meanwhile, some of the market’s biggest stocks, or as I like to call them, “buy-backers,” are the big Wall Street banks.
Yet, as I wrote to you last year, while the Fed was launching its aggressive rate hike program, the banks submitted results of stress tests. These tests indicate how healthy they would be if they had to withstand a major financial shock.
As a result of poor stress test results, both JPMorgan Chase and Wells Fargo paused their buyback programs last summer.
But now, as the Fed has entered Stage 1 of its three-stage pivot, which involves easing its interest rate hikes, Wall Street is back to planning its share buying with a vengeance.
JPMorgan is targeting a $12 billion share buyback amount, as what it calls a “good” number.
Wells Fargo has also announced it will step up its buyback program this year.
What’s more, at its first quarterly earnings meeting this year, Bank of America stated it expects to increase the pace of last year’s buybacks. Plus, the large global banks UBS and UniCredit announced an increase in 2023 buybacks after posting strong earnings results to start off the year.
But tech and banks aren’t alone.
The energy sector has been flexing its buyback muscle, too. So far this year, the biggest buyback announcement came from Chevron. Its $75 billion figure made up more than half of the total buybacks announced for January.
(Even without them, January’s buyback total stood at $57 billion, the fourth-largest total for January ever.)
After a banner year in 2022, Chevron, the second-largest fuel company in America, announced $75 billion in anticipated share buybacks for 2023.
This is interesting because not only did the White House decry Chevron’s buyback size, but the government had already decided to dissuade American companies from stock buybacks.
You see, there’s a new law that takes effect this year that slaps a 1% tax on buybacks. That law is called the Inflation Reduction Act. We’ve spoken a lot about that act with respect to elevating parts of the domestic supply chain and investment in energy and infrastructure development.
But it’s Sec. 10201 of the IRA that sets a non-deductible 1% tax on stock repurchased by publicly traded domestic corporations.
Even so, you can basically ignore that law. Because U.S. firms don’t care about it. To Chevron and other mega companies, that tax is like a small traffic ticket on the highway to higher share prices.
And that’s much to President Biden’s chagrin, which is why he suggested quadrupling the tax in his recent State of the Union address.
In Biden’s own words:
Corporations ought to do the right thing.
That’s why I propose we quadruple the tax on corporate stock buybacks and encourage long-term investments.
Despite Biden’s efforts, a 4% tax on buybacks – which seems unlikely to pass amidst a divided Congress – won’t dent the stream of buybacks, either.
Buybacks Offer Investment Clues
Last year, I said that corporate stock buybacks would hit another record in 2022. I said:
That means more money coming in. And that tells me that buybacks will hit another record in 2022…
And as it turned out, even with the dismal market behavior, they did hit a record.
In fact, in 2022, the S&P 500 buyback index outperformed the S&P 500 index.
Just think about that. Without the extra demand coming from companies for their own shares, it’s likely that the market could have looked much worse last year.
But all this buyback activity can propel stock prices higher, especially if other factors are involved.
Greater buyback announcements, buyback trade execution, and retail and institutional demand can all contribute to higher share prices. And when you throw in the fact that we are in Stage 1 of the Fed’s pivot, there’s reason to believe this early year rally has legs.
That’s why we think that 2023 will be an even bigger buyback year – and set another record.
And one way to take advantage of this trend is through the PKW Invesco Buyback Achievers ETF. It’s an exchange-traded fund that tracks the 100 stocks with the highest buyback ratios.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins