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Share Buybacks May Not Be What They Seem

Apr 30, 2018

In contrast to large-scale share buybacks initiatives that are common among US companies, European firms are choosing a different method to return excess capital to shareholders. As Justin Lee details in his piece “European Company Profits Are Rising, But Where’s the Payout”, European companies have deprioritized stock repurchases, and instead are focusing on capital expenditures and buying down debt. The preference of European firms to use excess earnings differently is apparent this earnings season, which has been particularly strong and left many firms flush with cash.  While a lack of repurchases appears to negatively impact the bottom line of shareholders, as buying shares tends to lift a stock’s price in the near term, it may benefit investors in the long run that companies are seeking alternative methods for distributing cash.  

The stock buyback programs utilized by various US firms are often seen as effective, as they have a relatively immediate and tangible impact for shareholders. Although a share repurchase program may interest traders or investors with shorter investment time horizons, repeated share buybacks may concern investors with longer investment time horizons. Funds used to re-acquire shares would normally be earmarked for capex and other investment opportunities. In the long-term, a continual lack of commitment to reinvestment in the form of capital expenditures and R&D projects materially impair a company’s growth outlook. Repeated share repurchases may also signal that a company’s “investment well” has run dry. While this wouldn’t be an issue for investors who have a higher portfolio turnover, it may be concerning to those planning to hold shares for extended periods. 

While it can be argued that repurchasing stock may be healthy for a company’s balance sheet, as the company is able to increase the amount of its own equity that is held, it can also be suggested that buying down debt would be a superior use of funds. Keeping debt levels low allows companies to operate with more flexibility and allows a firm to raise debt at lower costs should an opportunity arise. 

Looking beyond individual stocks, continual stock repurchases can be detrimental to a country’s economy. The investments that a company makes with excess funding could potentially spur job creation and boost economic productivity. The money paid to investors in exchange for shares, though it may be used to stimulate economic activity in other forms, may also be saved by investors which could harm economic output.

Share buybacks typically receive more publicity and attention from investors than capital investment and debt reduction. The rapid affect that a share repurchase can have on a stock’s price can provide a sense of confidence among investors that the company is thriving when it may actually be a warning sign. Forgoing share reacquisition is like taking medicine, it’s painful now but in the long run investors may better off for it.  

The full Bloomberg Market article discussed: