Stock Buybacks or share repurchases constitute a major chunk of the financial spectrum.
And with the current circumstances of the financial system, it is a no-brainer to conclude that these have been hard hit as well.
So, let’s dive right in to understand the reason every financial news channel and journals are talking about these.
So, what are Stock Buybacks?
As the name suggests, stock buybacks are a situation in which a company repurchases its own shares. Most (95%) of the share repurchases are done from the open market.
The logical question to ask here would be: why?
Why would a company buy its ownshares back, if they sold it to the public in the first place?
Doesn’t make much sense, right?
Well, to understand the rationale behind this, we have to descend into basic finance:
When a company buys back its own shares, it decreases the amount of outstanding shares(shares of the company which are available for buying) in the market.
The Earning Per Share or the EPS matrix is one of the major indicator of a share’s value and is calculated as:
EPS = Earnings of the company/ No. Of shares outstanding
Hence, the decrease in the shares outstanding will increase EPS of the share, which will lead to an increase in stock price, which improves the image of the company in the eyes of the investor, at the same time, increasing the wealth of the shareholders.
Pretty neat, eh?
(I hope this did not get too technical)
Buybacks in the recent past:
Though, in India, due to the heavy taxation imposed by the Modi Government on Buybacks, it has gone down.
One of the arguments behind it being to ensure that companies give some cash to shareholders.
The policy was faced with criticism, with the accusations that the taxes show decreased trust in the market, and that the policy does little to redirect corporate energy towards investment.
Nilesh Shah, manager of Kotak Mahindra Asset Management co has accused that the Government sees market players as “speculators and not investors.” He further went on to say that these taxes “hurt entrepreneurialism and ultimately the investment that policy makers want.”
These accusations were even backed by some of the noted financialist and policy makers, chief among them, Urjit Patel, the Governor of Central Bank till last December, who believes that the Indian Government is taking a narrow stand on the whole situation, not being able to understand the whole picture and realise that these financial duties hurt investment.
The United States Scenario:
Picture: Trump passed a tax cut bill in 2017 which has had mixed results.
On the other side of the spectrum is the United States Of America.
Historically a place where companies have invested in buybacks, the tax cut imposed by the Trump administration in 2017 saw a sudden surge in the level of money spent on the same.
US Senator Marco Rubio has reportedly blasted the tax cut implying that it was benefitting companies more than the workers.
A WSJ reporter rightly pointed out that the money that the companies had saved from the tax cut and which the Government thought would be re-invested in the company, actually went to share buybacks.
A professor of Bocconi University, Milan who wrote a paper on buybacks some time back, when asked about the surge, said
“From both sides of the political spectrum, there are accusations that companies spend a lot of money on buybacks, and they invest less”
In the 4th quarter of 2019 only, the S&P 500 companies invested around $189 billion in buybacks and even that was not the highest.
Since 2010, companies have invested around $5.3 trillion in overall stock buybacks.
Though American Airlines have claimed that it had put more of its free cash on the company’s development and growth rather than buybacks
The report comes at a bad time for the airline companies as the fall in ridership and business as a result, have made them need to be bailed out.
Buybacks are good! (?)
When I introduced buybacks, I said that it benefits the shareholders.
But that’s just one part of the story. Though there are many supporters of stock buybacks, the critics are the same number if not more.
One of the major points against buybacks is that the company uses the money which could have been used elsewhere for the development of the business as a whole.
Picture: The amount invested in businesses have gone down since 2013.
The fate of Airlines:
The most immediate proof of the same is the fate of the airlines. Having not used their cash in business development, they are at a place from which they need to be bailed out.
The pertinent argument that boils up everytime the bail out is discussed, is
when they spent so much purchasing their own shares and not re-investing in the company, do they deserve to be bailed out?
Buybacks and Debt:
Companies mostly finance these buybacks through debt, and the increasing levels of Buybacks in turn refer to increasing levels of leverage increasing the overall risk of the market.
With the scars of the 2007-08 recession still fresh, and over-usage of debt being one of its principal factors, many argue that so much risk is not correct for the market stability.
Selfish American Corporates (?)
Another argument made is the fact that there is a growing culture in corporations where even high ranking officials such as CEOs hold the company shares. Hence, they have a personal benefit whenever share prices go up.
And thus, to make more of their own money and ignoring the overall growth of the company and the benefits of the shareholders over the long run, they focus more on buybacks!
The Pandemic and Buybacks
As an aid for companies of all scales throughout the nation, the Donald Trump administration passed a $2 trillion aid bill which includes various deals, one of them, being that the companies getting the aid will have a one year ban imposed on them on buybacks.
The business has gone down a lot during this pandemic, along with the company’s profits, and as a result companies have been dropping their plans of stock buybacks.
A Forbes report says that the repurchase will decline by 50% to $ 371 billion during 2020.
So, the pandemic has brought a change to the financial market structure in the United States. Buybacks, which were on a sky rise promise to fall in the current year, and with the provisions of the bill, afterwards, too.
It is a great win for the critics of the Buybacks, whereas the supporters will not be a happy bunch.
Though the future is uncertain, this ban will clarify, which stand was more potent.