Buying Back Wrong

Investors tend to be fans of share buybacks, thanks to their ability to boost demand for stocks. Buybacks also reduce the number of shares outstanding, giving each remaining share a larger stake in the company. That increases earnings per share and also reduces the company's total dividend commitment.

For most investors, buybacks have tax advantages over dividends. Dividends are taxed at shareholders' ordinary income tax rates. Starting next year, buybacks by corporations will be subject to a 1% tax.

But to the extent that they boost stock prices, investors don't owe anything to the taxman until they sell their shares, triggering a capital gain. And that's usually taxed at a lower rate than income. 

The timing of buybacks is up to a company's board of directors and management. And, the thing is, it turns out that those insiders very often aren't great at judging the value of their company's stock.

Companies tend to increase buybacks when their stock price is surging, and decrease buybacks when the stock is down. It's the opposite of the buy-low-sell-high mantra for investing success.

When companies are doing well and generating excess earnings and cash flow, they tend to direct it toward buybacks. But that's exactly when the market is likely to be already rewarding their stocks.

And during lean times, when the stock might be depressed, buybacks tend to be put on hold. Shareholders might like to see the exact opposite behavior from their companies. Dividends, by contrast, tend to be much more consistent and are only cut during the worst-case scenarios for businesses.

A recent buyback offender has been Meta Platforms. Here's Barron's Andrew Bary writing today:

Meta spent $48 billion and bought back 158 million shares—roughly 6% of the stock outstanding—for an average of $304 a share over the past four quarters. It has effectively overpaid by $27 billion based on its current share price, which is off 60% this year to $133.

Making things worse, Meta has sharply slowed its buyback activity this year as its earnings have come under pressure. Meta’s earnings are expected to drop 26% this year to about $10 a share. The stock is trading at about 13 times earnings, its lowest price-to-earnings ratio since Meta went public in 2012. Just when many investors might like to see aggressive stock repurchases, Meta isn’t doing them. The company is investing heavily in its pivot to the Metaverse.

In a statement to Barron’s, Meta said: “There are various considerations that factor into the size of our share repurchases, including the relative strength of our balance sheet and free cash flow projections for the balance of the year.”

Meta has $24 billion remaining in its share buyback authorization and had nearly $40 billion in cash on its balance sheet at the end of the second quarter. So it still has plenty of capacity to buy back stock, should it choose to buy the dip.

Other buyback offenders of late have been the big U.S. banks, including JPMorgan Chase, Citigroup, and Wells Fargo. All three bought back zero stock in the third quarter, compared with large repurchases in the year-ago period when their share prices were significantly higher.

Read the rest of Andrew's article here.