The controversial stock buyback has met its most formidable opponent perhaps ever.
Its name is coronavirus.
With household name companies like Delta Air Lines, Intel and others in search of cash as the U.S. economy grinds to a complete stop amid the pandemic, numerous executives are likely wondering why they spent so lavishly to prop up their stock price by way of the mighty buyback from 2017 to 2019. Was it really worth it in hindsight to use any weakness in the market for one’s stock to call up bankers and put a bid into buy said stock into the closing bell?
The resounding answer is probably hell no, especially as stock prices have cratered from their record highs inside of two months and it’s anyone’s guess when the global economy will rebound with vigor. That cash could have been used today to keep nervous workers on the payrolls during the height of the coronavirus, buy a wounded competitor to ignite strong post recession growth or support more aggressively the coronavirus relief effort.
Make no mistake, the market is on the cusp of losing a major crutch known as the stock buyback. And with the long-term support function relegated to the dustbin, investors of all kinds best be prepared for a new normal level of volatility.
The numbers on buybacks are despicable
At least big companies have gotten the memo that announcing stock buyback plans now — or executing on existing authorizations — are as smart as having a liquored-up party.
Since the start of March, 51 companies amounting to 27% of 2019 aggregate buybacks have suspended their repurchase programs, according to Goldman Sachs. Some of the most prominent companies that have suspended buybacks include airlines United Airlines, Delta and Alaska Air. Chipmaker Intel has put a halt on its buyback plan (the company spent $13.5 billion on buybacks last year, per Goldman Sachs data). Eight of the largest banks have temporarily put an end to buybacks currently, too.
No surprise with the airlines, however, as air travel demand has almost completely dried up amid social distancing mandates by global governments.
Moreover, the airlines are preparing for their own revised future under the Coronavirus Aid, Relief and Economic Security (CARES) Act. When the airlines reach for relief money — and they plan to do so to stay in business — they will be unable to repurchase stock or pay a dividend until 12 months after the loan is repaid.
In total, Goldman Sachs expects S&P 500 share repurchases will fall by 50% to $371 billion this year. Including an estimated 40% drop in buybacks in the first quarter of 2021, Goldman estimates repurchase volume will be 65% below the 2018 peak by that quarter end.
Minus corporate buying of stock, Goldman thinks the market could get rockier. They are 100% correct as buyback activity has kept a flame under the post Great Recession bull market (which is now mere history).
“The decline in share repurchases will have a significant impact on the equity market. Corporate buybacks have far exceeded demand from all other investor categories combined since 2010. The removal of the principal buyer of shares will widen trading ranges and increase volatility. Reduced buyback spending means less downside support for equity prices since fewer firms will step in to repurchase shares if their stock prices fall,” points out Goldman Sachs strategist David Kostin.
Remember “buy the dip” which worked so magically these past 10 years? Well, you could toss that in the trash as buyback activity dries up.
“I do not think buybacks will become extinct but they will likely be much lower for some time. Companies are set to become much more judicious in buying back stock. Companies will likely only do buybacks gradually and after there is clarity on the duration and depth of the economic downturn caused by the coronavirus,” cautions SunTrust chief markets strategist Keith Lerner.
Good riddance to buybacks
Throughout the halls of Davos this year (which feels like a lifetime ago), all I heard was executives and various influencers pontificate on the need for a stakeholder capitalism model. Traditional capitalism and its Gordon Gekko greed is good undertone is dead, opined the affluent in attendance. Enriching institutional shareholders and executives is oh so bad at the expense of average workers and shareholders.
Long live stakeholder capitalism was the mantra on every stage — a model that is supposed to enrich everyone from the Harvard educated CEO to a factory line worker to the school down the block from the factory.
So where in the world has the action been on this front? Stakeholder capitalism isn’t some grand new idea, per se. So far it has been a whole lot of hot air and soundbites by executives. Companies have plowed $1.6 trillion into stock buybacks in 2018 and 2019, far exceeding the $1.1 trillion spent in 2006 and 2007. One of the loudest voices in the room on stakeholder capitalism — BlackRock CEO Larry Fink. BlackRock spent $1.9 billion on stock buybacks in 2019, according to its annual report. What’s up with that, Larry?
Ultimately, stock prices have stayed nicely afloat the past two years thanks to the buybacks (funded in part by the Trump tax cuts) even as earnings growth has slowed. Gobs of executives have made bank as their bonuses are still tied to earnings per share growth — which is boosted by buybacks — in countless instances.
Not all companies in Corporate America are doing it wrong when it comes to using free cash flow. Some have lifted dividends to support longer term investors. Some have done that and reinvested in higher wages for employees and game-changing R&D. But so many have fallen woefully short, and they are paying a dear price today for their out of touch ways.
Let’s hope the coronavirus pandemic brings about the end of the terribly misguided stock buyback. Maybe that is done through legislation. Maybe that is done by public shaming of companies that go for broke with a splashy new buyback announcement delivered via a press release after the close of trading.
Whatever the case, in the long-run markets and humanity will be far better off in a world minus this major market crutch.