How Buybacks Came to Drive the Stock Market

Dec 01, 2023

The biggest buyers of stocks on US exchanges aren't pension funds or retail investors. The dominant force in the equities market is companies buying their own shares. Stock buybacks, as the practice is known, please shareholders by boosting the worth of their holdings — and benefit managers whose bonuses are tied to stock prices. Buybacks have drawn criticism from President Joe Biden and his predecessor, Donald Trump, who both said they’d rather see companies use profits to create new jobs. Buybacks set a record in 2022 even as Congress voted to impose a 1% tax on them. Many analysts are forecasting a drop in 2023, not because of the new tax but as companies conserve cash in the face of an expected economic slowdown.

1. How do buybacks work?

Investors buy a stock because they hope its price will rise and to get a share of the company's profits. The traditional way for a company to distribute profits is through dividends, payments made directly to shareholders. Buybacks benefit shareholders in two slightly more indirect ways: Adding to the demand for the stock can lift or support its value, and buybacks can make stocks more attractive by improving financial metrics like earnings per share, since a company's profits will be divided among fewer shares.

2. How big are they?

Since the US cut corporate taxes in 2018, buybacks have gone up every year except during the pandemic turmoil of 2020, reaching $923 billion in 2022. More money has been spent on buybacks than dividends in every quarter but two since 2010 for companies in the S&P 500 Index. Buybacks have been the largest source of demand for equities for more than 10 years, according to Goldman Sachs Group Inc.

3. Why do so many companies do them?

As part of President Ronald Reagan's deregulation drive in the 1980s, restrictions on buybacks were loosened and managers’ bonuses were increasingly tied to stock performance. The result? Over time, the stock market's perceived function — raising money for business ventures — was turned on its head, as stocks became the main vehicle used to return money to shareholders. Companies began to borrow to do so. For example, Meta Platforms Inc. issued $10 billion of debt in August 2022 and $8.5 billion more in March that it used for, among other things, buying $28 billion of its stock in 2022 and more than $9 billion in the first quarter of 2023.

4. What's the argument for buybacks?

Proponents say that corporate profits belong to shareholders, and that buybacks shouldn't be any more controversial than dividend payments. Buybacks are more flexible than dividends, which companies generally seek to continue at set levels through good times and bad. They also offer tax advantages to shareholders, since their benefit comes in the form of capital gains that aren't taxed until the stock is sold, while dividends are taxed when they’re paid out. Defenders also argue that society benefits if a mature company with limited opportunities to grow hands that money to investors who can put it to use in startups or elsewhere.

5. Why did buybacks become a target?

As their volume has grown, so has the criticism. Opponents say these bonanzas for shareholders slow economic growth and increase inequality by consuming resources that could have been used to grow the company or for boosting hiring and employee salaries. Buybacks exceeded capital expenditures over the five years through 2017 while wages stagnated. In a 2023 study, two economists calculated that between 2001 and 2022, Cisco Systems Inc. spent 95% of its net income on buybacks, a focus on its stock price they said had come at the expense of investment and innovation. The US Securities and Exchange Commission in May adopted rules requiring companies to disclose more information to make it easier for investors to compare the timing of buybacks and insider trades, and identify buybacks designed primarily to boost executive compensation.

6. What's the outlook?

Completed buybacks will likely drop 15% this year, according to a May estimate from Goldman Sachs strategists, but not because of the new tax, which was widely seen as too low to meet its goal of discouraging buybacks. (Biden has proposed raising it to 4%.) Corporate profits shrank in the last half of 2022 and are expected to sag again in 2023, when many Wall Street economists and Federal Reserve officials are forecasting a recession to begin.

7. Are buybacks an issue elsewhere?

Companies in Europe have traditionally favored dividends, but buybacks have surged there in recent years. Companies there announced buybacks of nearly $70 billion in the first two months of 2023, up 50% from the same period in 2022, Bloomberg Intelligence reported, led by energy firms flush with cash from higher oil prices and banks, whose income got a boost from higher rates.

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