Stock buybacks and dividends become a $1.5 trillion political target
Despite the tough stock market and slowing economy, corporate America is sending more cash to shareholders than ever before.
The amounts are staggering, which is why these colossal sums, sometimes called “windfall profits”, have become a political target.
The landmark climate and tax legislation now going to President Biden for his signature includes a new 1% tax on buyouts, for example.
Senator Chuck Schumer, the New York Democrat and Senate Majority Leader, announced the new tax with a succinct critique. “I hate stock buybacks,” he said. “I think they’re one of the most selfish things corporate America does.”
Yet redemptions and dividends are extremely important to investors.
Consider that S&P 500 companies will spend more than $500 billion on dividends this year and more than $1 trillion on stock buybacks, according to S&P Dow Jones Indices principal analyst Howard Silverblatt. That’s a total of $1.5 trillion, more than ever before.
No wonder these huge cash flows are getting attention.
As investors, consumers or ordinary citizens of the planet, it is worth considering the importance of buybacks and dividends – whether they are a form of self-serving corporate profligacy, a wise use of capital or perhaps some something in between, as Aswath Damodaran, a New York University finance professor, suggests.
“It’s really about price and value,” he said in an interview. “Returning money to investors is a good thing, if the company doesn’t put it to better use. It’s a bad thing if it’s done in a way that destroys shareholder value. It’s all in the numbers.
Windfall gains versus stable profits
Windfall earnings from energy companies supported buyback and dividend totals.
ConocoPhillips announced earlier this month that, through a special dividend, it was making “a $5 billion increase in the return of capital scheduled for 2022 to $15 billion.” EOG Resources made a similar move by declaring a special dividend of $1.50 per share, double its regular quarterly dividend. And Exxon Mobil said while maintaining its dividend, it would spend $30 billion on buybacks, tripling the previous total.
From a classic economic perspective, strong profits for energy companies this year are exactly what one would expect from a sudden shock to global supply, caused in large part by Russia’s war in Ukraine. and Western sanctions. Companies that extract, refine and distribute oil and gas make huge amounts of money. While the S&P 500 has fallen this year, energy companies have gained more than 40%, according to FactSet, far more than any other sector.
A moral dilemma
If you own stocks in a broad index fund, you own a portion of those companies and they have boosted your own returns. In financial terms, this is a wonderful thing.
What is Inflation? Inflation is a loss of purchasing power over time, which means your dollar won’t go as far tomorrow as it did today. It is usually expressed as the annual change in the prices of common goods and services such as food, furniture, clothing, transport and toys.
But is it immoral?
United Nations Secretary General António Guterres says so. “It is immoral that oil and gas companies are making record profits out of this energy crisis on the backs of the poorest people and communities and at enormous cost to the climate,” Mr. Guterres told reporters at the headquarters of the UN in New York. August 3.
Along the same lines, President Biden said in June, “Exxon has made more money than God this year” and criticized the company for its intention to spend the $30 billion on stock buybacks, rather than capital investment for oil drilling. The company says it does both and buybacks are good for investors.
All of these companies are under government and shareholder pressure to switch to greener fuels – appropriately, in my view. And many should go much faster. But the world still needs the energy they sell, so they and their shareholders benefit.
Consider the US companies that had so much cash that they dominated the buyback market in the 12 months to June. None was an energy company. The leader, according to the S&P Dow Jones indices, was Apple, with $91.3 billion in buyouts. The other major takeover companies were Alphabet (parent company of Google), Meta Platforms (which owns Facebook), Microsoft and Bank of America.
“Companies like Microsoft and Apple have bargains year after year,” said Yung-Yu Ma, chief investment strategist for BMO Wealth Management in the United States. “You don’t hear much about taxing their ‘windfall’ profits, though.”
Modern dividend-paying companies are sometimes considered Steady Eddies – reliable providers of steady income.
Caterpillar, Clorox, Coca-Cola, Colgate-Palmolive and T. Rowe Price, as well as Chevron and Exxon, are among them.
“When markets are going up 20% a year, people tend to forget about dividends,” John Linehan, portfolio manager of the T. Rowe Price Equity Income Fund, said in an interview. “But the longer your investment horizon, the more important the dividends are to you.”
This is evident in the returns calculated by Mr. Silverblatt. While the S&P 500’s average return from 1926 to June was 3.5% – about double what it is today – due to capitalization, dividends made up 38.2% of the total return of the S&P 500. index, according to his calculations.
Measuring the effects of takeovers is more difficult. Buybacks are often said to increase stock value by reducing the number of shares, thereby increasing earnings per share. Buybacks are also said to be responsible for much of the stock market’s upward moves lately. The proof, however, is more complicated.
An unintended consequence
“It is unclear that for many years after the Great Crash of 1929, the Securities and Exchange Commission (SEC) viewed takeovers as verging on criminal activity,” wrote Edward Yardeni and Joseph Abbott of the independent Yardeni firm. Research, in their book. , “Share Buybacks: The Real Story”.
The authors say the growth in buyouts is partly an unintended consequence of a 1993 tax code change under President Bill Clinton that placed a $1 million cap on CEO salaries. Always inventive, companies have accelerated the issuance of stock options and awards as a form of executive compensation.
As The New York Times has documented for many years, these grants have created a pay gap with rank-and-file employees, creating billionaires in the executive suite.
When shares are thus issued to corporate executives and ordinary employees, the participation of existing shareholders is diluted. Let’s say, for example, that you own 1 in 100 shares in a small company. After issuing 10 new shares to company employees, you will only own 1/110th of the company.
Understand inflation and how it affects you
But the company is remedying this dilution through buybacks. This prevents the value of your shares from falling. When redemptions are larger – reducing the total number of shares to, say, 90 – the value of your shares increases.
A study by Citi Research found that S&P 500 companies made $882 billion in total buybacks last year, but after factoring in stock dilution, only $620 billion in buybacks remained. Only this part can reasonably be described as returning shareholder value.
The effects of share buybacks on stock prices are ambiguous. S&P 500 stocks with the biggest buybacks outperformed the broader S&P 500 over the 10 years through July, but underperformed the broader S&P 500 over five years. Whether these purchases are indeed pushing up stock returns, the numbers don’t show it conclusively.
When money can be reinvested more productively by a company, shareholders are better off without dividends or redemptions.
Warren Buffett explained it to Berkshire Hathaway shareholders. “Our shareholders are much richer today than they would be if the funds we used for acquisitions had instead been spent on stock buybacks or dividends,” he wrote in his letter to shareholders. of 2012.
While it buys stocks of companies paying dividends for Berkshire, Berkshire itself pays no dividends because it says it can better invest the money itself. Berkshire repurchases shares – it has done so recently – when Mr Buffett considers the price a bargain. Buying stocks at too high a price destroys value.
This is fundamental financial theory. There’s an art to making practical decisions that don’t just enrich corporate executives.
From this perspective, when windfall gains are not accompanied by attractive opportunities for corporate reinvestment, buyouts or special dividends are excellent uses of corporate cash.
The new 1% tax could shift some corporate spending from buyouts to dividends, Ma said. But between them, dividends and buyouts will remain important ways for companies to return profits to shareholders.
Whether that money comes in regularly or as windfalls can matter a lot if you need to tap into it now.
But, fundamentally, what matters is the companies’ ability to generate a torrent of cash. As long as there is plenty of it and it accumulates over long periods of time, you will thrive.
Windfall profits? Let’s do more, as often as possible.