Why should a financial planner be concerned about stock buybacks?
The only thing I don’t like about financial planning and the overall study of economics is that I must pay attention to the news, especially what’s happening in Washington, DC. As many of you already know, I loathe politics. The concept is great and I love my country.
However, I am very tired of watching my political leaders lie, cheat, blame, and bicker instead of doing their job. It’s hard to admire people when they are doing all of the things my parents and mentors taught me were wrong. Usually, political press conferences are fluff where new ideas are spouted off, but forgotten in a week. Once in a while things do get accomplished, so financial planners must be prepared to adjust your plan.
The funny thing about the news is that the narrative changes depending on what channel you’re watching. Sometimes this is because of the channel’s target audience, but I also think it’s because each reporter has a different voice. We all do! Ask two strangers to define a word and you’ll probably get two completely different answers, both of which can be technically correct.
Recently, President Biden has been focused on punishing corporations for doing stock buybacks by creating another tax. His main argument is that CEO’s use stock buybacks to raise the stock price in order to raise their compensation. Sure, a stock buyback can result in an increase of the stock price, but is the CEO the only one who benefits from this strategy?
What is a stock buyback?
To understand what stock buybacks are, I think it helps to think about why a company issues stock in the first place. Companies are so large now by the time they go public we seem to forget companies sell stock to raise money. We, as investors, buy the shares and become part owners of the company.
No, most investors never go in the corporate office and the employees will likely never know their names. Basically, by purchasing shares we are giving the company a loan, which may or may not be paid back. Yes, there are risks to investments, but there can also be great rewards.
Fortunately, there are laws to help protect investors. For example, company CEO’s have a fiduciary duty to all shareholders. That includes everyone from the top executive to the person whose grandparents purchased them a share for a birthday present. As a Certified Financial Planner™, I am also held to a fiduciary standard, which means my clients’ best interest takes priority over mine. I’m not sure if politicians are held to that standard, but they should be!
Stock buybacks can be considered as just a tool used to improve stock price.
Stock buybacks can be beneficial to all shareholders because it normally causes the stock price to rise. If we think of a stock buyback on a smaller scale, it’s like the company is paying you back for the “loan” you gave them when you purchased shares of the stock. If you loaned money to a friend or family member, wouldn’t you be happy to be paid back? Should we treat a big corporation any differently?
A stock’s valuation can be calculated as a multiple of earnings per share. A public company announces its earnings total divided by the number of shares outstanding. For example, instead of saying a huge number like $15 billion, the company says it earned $2.00 a share. We then decide if a stock is priced correctly by assigning it a multiple.
If the stock from our example was $30, then it has a 15 multiple because it earned $2.00 per share. Then, if the investor believes that multiple is too low, they buy more. However, if they believe it is too high, then they may sell their shares.
So, how can a company change its multiple?
When a company does a stock buyback, they are reducing the number of shares outstanding. Basic math tells us we can make an answer larger by decreasing the amount by which it is being divided. Therefore, a company’s earnings per share can be increased by decreasing the shares available for the public to purchase. If we value a stock as a multiple of earnings per share, then increasing earnings per share should lead to a higher stock price. Sounds good, right?
Well, it depends on the narrative. Unfortunately, stock buybacks are being used politically to divide us among the rich versus the poor. Big corporations are portrayed as villains with their executives using stock buybacks to line their own pockets while neglecting to mention it can help all shareholders.
My clients’ accounts come in all sizes. Don’t you think they would like their investments to rise? I can promise you they are all good people who love their family and are trying to build a better future. They are absolutely not rich villains and I’m fairly certain a majority of public company shareholders are in similar situations.
Another note on stock buybacks.
Furthermore, many of these large “evil” companies’ stocks are held in pension and retirement accounts. They may not be specific holdings, but these accounts are usually comprised of Mutual Funds and Exchange Traded Funds (ETFs). These investment products are normally made up of a variety of stocks.
Therefore, teachers, police officers, firefighters, and nurses can be impacted by a company’s stock price, not just the rich CEO. These American workers are the ones politicians always claim to protect. By being upset over tools that can raise our portfolios, are politicians really looking out for them? I would argue the future of a teacher after 30 years of service is almost as important as their present wellbeing.
To further clarify let’s look at an example. SPDR ETF’s are a popular choice in retirement portfolios because they allow us to invest in specific sectors of the S&P 500. According to Marketwatch.com as of February 22, 2023, the top two holdings in the SPDR Energy Sector ETF were Exxon and Chevron. As we all know, these companies are regularly criticized by politicians for making too much money.
Conclusion on stock buybacks.
Part of the job as a financial planner is education. I did not write this to sway you politically one way or the other, but to give you some additional perspective. I’ve always said money is a tool and nothing more. It is not good or evil. Similarly, stock buybacks are just one piece in a company’s tool box.
Investors have the freedom to “vote with their feet,” which means they can sell their stock if they disagree with how a company is being managed. They absolutely do not need the government to step in and tell companies how to survive and succeed. I am, however, all for a government attempt of the federal job guarantee discussed by Modern Monetary Theory.
Returning to the ETF example.
Let’s say Exxon hires more employees and increases production instead of distributing a dividend or executing a stock buyback. Remember, the oil industry is highly-regulated, so Exxon may not even be allowed to increase production. However, if allowed, increased production could impact supply and demand, which could cause all of those record profits to disappear.
Then all of those new employees would be laid off because Exxon bowed to the government pressure, which upset the delicate balance of supply and demand. Other industries could face the same challenges. Ford can only produce so many cars, Apple so many iPhones, and the list could go on all day long. Supply and demand can stop the world when out of balance, just look at the impact of shut downs during the COVID Pandemic. Toilet paper was worth its weight in gold in my community!
Personally, I think the government would do better by overhauling the current tax code instead of imposing their will on companies.
There are many loopholes used by corporations and individuals to avoid paying taxes. Before we vilify the wealthy for following these rules, maybe we should look at the people who write the laws. Our leaders may very well be using these loopholes themselves.
If we simplify the tax code, then maybe everyone would “pay their fair share” as we so often hear in the media. I would go so far as to be in favor of a flat income tax. Can you imagine how much easier it would be to budget and plan if we knew the government was going to take something like 10% instead of the confusing bracket system we use?
Many small businesses and individuals have already made the transition from “working to grow” to “doing whatever is needed to pay less taxes.” That is not a good formula for economic growth. The mental state of the American worker is just as important as the financial state. Ambition has a lot to do with attitude!
If you made it this far, thank you! I know this is a different subject from my usual posts, but I do think it is an important one. When confirmation bias is everywhere we look, I think it’s important to know a different perspective. This is especially true when it involves your money. If you need help managing your money with a different, nonbiased mindset, then email me!