The fireworks over share buybacks are duds

Stock repurchases go back to the earliest days of the republic.

  • By Jason Zweig,
  • The Wall Street Journal
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Share buybacks are as American as mom, apple pie and hot dogs on the Fourth of July.

You’d never guess that given the many politicians on both the left and the right who say share repurchases are a newfangled, evil spawn of deregulation. Buybacks, argue their critics, barely existed before the Securities and Exchange Commission changed a rule in 1982 and unleashed a multi-trillion-dollar torrent—enriching fat-cat investors, starving workers and stunting the long-term prospects of the companies buying back all those shares.

To call this argument baloney would be an insult to cold cuts. When American companies began repurchasing shares from their investors, Alexander Hamilton was treasury secretary—and corporations have been buying back stock, often a little and sometimes a lot, ever since.

A buyback is just what it sounds like: A company repurchases shares from the public, taking them off the market. Some of the earliest U.S. companies were told by government authorities to do just that. Ironically, that mandate to repurchase shares seems to have been motivated by the same fear shared by today’s opponents of buybacks: the risk of too much wealth and power ending up in too few hands.

In 1798, the Pennsylvania Legislature granted a corporate charter to the Germantown & Reading Turnpike Road Co. One requirement: If profits remained after a 9% annual dividend had been paid, the company would have to use “the said surplus” to buy back as many of its shares as possible at “the sums which were originally paid.” Other companies followed similar practices.

In the late 18th and early 19th centuries, as the historian Joseph Stancliffe Davis noted, many citizens and politicians didn’t trust corporations or their managers.

Mandatory stock buybacks—like the 6% to 10% dividends that were customary at the time—appear to have been intended to keep management from pocketing or wasting the public’s wealth.

Anything that kept profits from piling high in a company’s coffers could help deter managers from stealing, squandering or abusing their power. That would have made buybacks beneficial—a view many investors, analysts and economists still hold today.

The opposite view is that buybacks are bad because they line the pockets of wealthy outside shareholders, preventing executives from using corporate profits to serve the public interest—often with some government guidance. That idea isn’t new, either.

In 1965, the Harvard Business Review ran a series of articles and letters debating what it called “an important new trend”: the rapid growth in share repurchases by U.S. companies.

Between 1954 and 1963, 53% of New York Stock Exchange companies—“corporate ‘self-cannibals,’ ” as researcher Leo Guthart called them—reacquired stock.

Corporations had piled up their cash surpluses thanks largely to “reduced tax rates” and other government policies intended to help businesses invest for the future, wrote Carl Blumenschein, controller of Container Corp. of America, in a letter to the editor. “When this money is used to buy back the corporate stock on the open market, it defeats the basic goals of modernization and expansion.”

A buyback “is essentially a negative act which is inconsistent with constructive and aggressive management,” added Gordon Donaldson, a Harvard Business School professor. “Substantial repurchase of common stock is in a sense an admission of failure.”

Most companies didn’t repurchase many shares in the late 1960s and the 1970s; on average, buybacks totaled only about a tenth of dividends by dollar volume.

However, between 1971 and 1984, Teledyne Inc. bought back 90% of its stock under Chief Executive Henry Singleton—whom Warren Buffett’s business partner, Charlie Munger, calls “the smartest businessman I ever knew.” Other major repurchasers then included Geico Corp., Tandy Corp., and Washington Post Co.

In recent years, buybacks have boomed as never before. U.S. companies bought back $4.7 trillion of their own shares from 2009 through 2018, according to S&P Dow Jones Indices.

Buybacks have tailed off a bit in recent months, leading some analysts to worry that stock prices may be losing an important means of support.

Research does suggest that companies may sometimes use share buybacks to manipulate earnings or to give insiders a chance to cash out at higher prices. But the claim that corporations are repurchasing shares to goose short-term stock prices instead of investing in projects to boost long-term growth is just rubbish. Corporate spending on research and development is at all-time highs, and S&P 500 companies lavished a record $713 billion on capital expenditures in 2018.

The great investing analyst Benjamin Graham said that “efficient operation” is often incompatible with “efficient finance.” The better a company is at producing goods and services that customers like, the more likely it is to generate more cash than it possibly can use.

Companies that are awash in surplus profits often end up “empire building,” or spending on “less-than-ideal projects and investments, leading to poor subsequent growth,” as investors Robert Arnott and Cliff Asnesshave written. By keeping some of that excess cash out of managers’ hands, buybacks prevent a lot of empire building.

That’s a lesson that the founders of the U.S. seem to have understood—and that today’s politicians still need to learn.

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