Nobody Could Have Predicted

Wow. No one saw this coming! According to J.P. Morgan, corporations are using their windfall from the President’s big tax cut (both direct savings and repatriated cash) to do stock buybacks.

This gives me an opportunity to share some insight on this from one of our longtime readers. This is usually framed as a pay-off for corporations, which it undoubtedly is. But these buybacks may drive money even pretty narrowly among a corporations shareholders.

As you well know, there is a bit of a PR battle going on regarding how much of the corporate tax cuts are going to wage increases vs. lining shareholder pockets.

Lost in the back and forth, however, is an incredibly important point about share buybacks. First off, as an investor, I’m neutral on buybacks. More specifically, if a company is very judicious about it, i.e. they buy shares when shares are cheap and don’t when they’re expensive, I love buybacks. By the same token, indiscriminate share buybacks have been responsible for destroying a huge amount of shareholder value. In aggregate the problem is this. When earnings are booming, corporate coffers overflow and companies are tempted to either buy back shares or make acquisitions. Unfortunately, when earnings are booming share prices tend to boom also and that’s not the best time to be buying back shares or making acquisitions. As someone who invests in individual stocks on behalf of my clients, part of my job is to avoid companies that buy back shares indiscriminately.

But there’s a more subtle problem with share buybacks. If a company buys back 5% of it’s shares, ceteris paribus, that will lift earnings per share by 5%, which will drive up the share price and benefits shareholders. If instead you use the money to hike the dividend, or to issue a special dividend that also puts money in shareholders’ pockets. There is a relative benefit to the buyback in that it returns money to shareholders in the form of capital gains, which isn’t tax until/unless shares are sold. On the other hand, the argument goes, if you pay out more in dividends, that gives control to the shareholder who can decide what to do with it (at the price of paying taxes on the dividends). You can debate which is better for the average shareholder, but there is a very special shareholder about whom there is no debate. That is the CEO (and other senior executives). Their incentives (stock options, for example) are all based around increasing the share price. So much so that they are better off buying back shares even at stupid share prices that make the buybacks a sure loser for the average shareholder.

I don’t think you have to be much of a cynic to think that corporate CEOs have had the potential personal windfall associated with lower corporate tax rates in the back of their minds as they have lobbied for lowering the corporate tax rate over the last bunch of years.

And as far as the debate about where the dollars from corporate tax cuts are going, it’s too generous to say that the lion’s share is going to shareholders. That may be, but not without a massive chunk (tens of billions of dollars I would guess) going into the pockets of corporate CEOs.

Meanwhile, here’s a good take on how much mainstream media publications were taken in by the idea that corporations were spending their windfall on raises and bonuses.

Dear Reader,

When we asked recently what makes TPM different from other outlets, readers cited factors like honesty, curiosity, transparency, and our vibrant community. They also pointed to our ability to report on important stories and trends long before they are picked up by mainstream outlets; our ability to contextualize information within the arc of history; and our focus on the real-world consequences of the news.

Our unique approach to reporting and presenting the news, however, wouldn’t be possible without our readers’ support. That’s not just marketing speak, it’s true: our work would literally not be possible without readers deciding to become members. Not only does member support account for more than 80% of TPM’s revenue, our members have helped us build an engaged and informed community. Many of our best stories were born from reader tips and valuable member feedback.

We do what other news outlets can’t or won’t do because our members’ support gives us real independence.

If you enjoy reading TPM and value what we do, become a member today.

Latest Edblog
Masthead Masthead
Founder & Editor-in-Chief:
Executive Editor:
Managing Editor:
Associate Editor:
Investigations Desk:
Reporters:
Newswriters:
Director of Audience:
Editor at Large:
General Counsel:
Publisher:
Head of Product:
Director of Technology:
Associate Publisher:
Front End Developer:
Senior Designer: