Why Apple, Warren Buffett, And Others Use Stock Buybacks - YouTube

The sweeping tax reform measures passed in 2017

were supposed to spur corporations to reinvest

profits back into research and paying their own

employees, and by extension, create new jobs.

We are giving them a big beautiful Christmas

present in the form of a tremendous tax cut.

It'll also be tax reform and it'll create jobs.

The one-and-a-half trillion dollar plan took

effect in January 2018.

It lowered the corporate tax rate from 35 percent

to 21 percent and the hope was companies would

use that money for capital expenditures.

That includes physical equipment, offices in

factories and software or intellectual

property—and that would create jobs and other

employment opportunities.

Many businesses did spend more on internal

projects, at least initially. In

the first half of 2018, business spending was at

$341 billion, a 19 percent increase over 2017,

and money spent on research and development hit

$147 billion—a 14 percent increase.

But business investment slowed later in the year

as concerns about the economy grew. At

the same time, companies announced buybacks to

the tune of a record $1.1

trillion worth of their own stock.

The stock buyback debate has drawn the ire of

politicians on both sides of the aisle.

In an editorial in The New York Times, Senators

Chuck Schumer and Bernie Sanders pledged to

introduce buyback legislation.

Their bill would encourage companies to do

something for workers before they could buy back

stock and pledged to set minimum requirements for

investment in workers and the long-term strength

of the company as a precondition for corporation

entering into a share buyback plan.

At the same time, Republican Senator Marco Rubio

has suggested Congress raise the rate on capital

gains to discourage buybacks.

The mere suggestion Congress should address

buybacks drew a swift response.

This is basically legislators saying we know

better how to deploy corporate capital than the

managers in the business.

Now, let's look to history again.

Where has that led people?

When government officials decide that they're the

ones who can micromanage business—they're talking

about exactly how much to pay people how much

benefits to give them, that they can't do share

buybacks.

So what are stock buybacks? Buybacks

often occur when a company's CFO thinks a stock

is undervalued.

When a company has excess cash, it can do one of

several things: Invest that money into their

business by upgrading equipment or real

estate, acquire another business, pay dividends

directly to shareholders or buyback its own

shares.

Buybacks come in different shapes and sizes. And

while they can be indicative of a company's

performance, that's not always the case.

Buybacks by themselves are no reason to own a

stock and in some circumstances are actually

reason to sell it.

I think you never want to own a stock of a

company is wasting the money it needs to survive

on useless buybacks, or even worse, spending

money it doesn't even have an activity as

fruitless as repurchasing its stock

at what you call a bottom. And

you shouldn't rely on even the largest buyback to

help prop up a stock, if the situation's dire.

The first and most obvious benefit is a boost in

the stock's price.

When a company buys back shares, it reduces the

number of shares outstanding.

If profitability remains the same, it will

increase a company's earnings per share. Buybacks

are generally taxed at the capital gains rate

while dividends are taxed as income.

And if the stock is owned beyond one year, the

cap gains rate is even lower.

Buybacks can signal good cash flow.

Finally a company that has excess cash to buy

back shares is generally in good shape when it

comes to cash flow, which boosts investor

confidence over the long term. Of

the companies that initiated buybacks in the last

year, these were the best performers.

Critics say buybacks are a form of financial

engineering that does nothing to improve

business. They can also provide cover for poor

financials. The artificial lift a buyback often

brings can mask greater problems at a company.

Companies are notoriously bad at timing the

repurchase of shares. As

a result, they often end up paying more for

shares than they should.

Legendary investor Charlie Munger sees that as

one of the biggest problems of buybacks.

Generally speaking, I'm restrained in my

enthusiasm for politicians telling corporations

what they should do.

But, I will say this: When it was a very good

idea for companies to buy back their stock, they

didn't do very much.

And when the stocks got so high priced that it's

frequently a bad idea, they're doing a lot.

Welcome to adult life.

This is the way it is. But

it's questionable at the present levels whether

a lot of it's smart. Was Eddie Lampert smart to

buy so much Sears Roebuck? No. And there's a lot of that kind of mistake that's been made.

The short-term spike that stocks often get can

allow insiders to profit.

Most times, those insiders are executives or

founders since they're often major shareholders

in their own companies.

Recently, Senator Chris Van Hollen proposed

barring corporate insiders from selling stock

within a prescribed time after a buyback was

announced. SEC Commissioner Robert Jackson, Jr.,

recently expressed his belief that most buybacks

are better for executives than shareholders.

Last year, he appeared on CNBC to discuss why

buyback rules should be re-examined.

After the Trump tax cuts passed billions upon

billions of dollars have been used for

shareholder buybacks in large public companies

across the United States. And

in the speech that I gave, I showed that those

buybacks are accompanied by, at the same time the

company buys back shares, the executive sells

into the buyback.

Now, we were clear in this speech that that's not

necessarily insider trading or fraud but it is

troubling, because when an executive does a

buyback they're suggesting to the market that the

stock is cheap.

And the question I'm asking is, if the stock is

cheap, then why is the executive selling into the

buyback.

As a result, there may be new momentum within the

SEC to change the rules.

Jackson responded to Van Hollen's concerns with a

letter. The commissioner said he found that from

January 2017 through the end of 2018, insiders

sell more stock right after buyback

announcements. That indicated to Jackson the

repurchases were more geared to executive

enrichment and less to the interests of the

shareholders or the benefit of the company.

Another problem with buybacks is that share prices

will eventually settle back to their previous

levels when investors realize the company's done

nothing to increase value.

And finally, some investors just prefer dividends

over buybacks.

These were the worst performers among companies

that have initiated buybacks.

So what, if anything, should be done to stem the

buyback tide?

While many Republicans believe there's nothing to

be fixed, there are several suggestions floating

around Washington.

One from Senator Tammy Baldwin would eliminate

the 1982 regulatory change that enabled such

large buybacks in the first place.

Schumer and Sanders would tie buybacks to a $15

minimum wage and other improved worker benefits.

And Senator Rubio would tweak the tax code to

eliminate what he calls an artificial incentive

for buybacks.

Jackson has suggested an open comment period on

rules for stock buybacks.

Regardless it appears the firestorm about stock

buybacks is just beginning Schumer's office

didn't offer specific time on when he might

introduce the legislation.

The bill is unlikely to make it through the

Senate, though, or make it to President Trump's

desk.