It’s not the buybacks, it’s the issuance: James Saft

October 14, 2015

Oct 14 (Reuters) – Investors appear to be getting wise to
the buyback illusion, looking not just at shares being
extinguished but at the greater number being created.

By any measure, the buyback binge pursued by U.S. companies
has been huge, with S&P 500 companies buying back $553.5 billion
in the year to June, up 3.8 percent from the year before.
Overall, almost $700 billion was bought back in 2014 by
U.S.-held companies, according to Research Affiliates data.

Just looking at the S&P 500, the buybacks equate to
2.9 percent of the index’s market capitalization.

Yet while the combination of buybacks and dividends is often
referred to as “total shareholder return” that’s actually a
misnomer, just it would be if you called your purchase of an
asset with borrowed money an increase in wealth.

Research Affiliates did a detailed study comparing the
amount of stock U.S. companies issued during the same period
they were also rebuying shares. This task is not made easy by
companies, and requires not just a close read of cashflows but
also comparisons derived from stock price movements and market
capitalization data.

The result: those companies which bought back almost $700
billion in 2014 issued $1.2 trillion worth of stock and took on
just about $700 billion of debt while doing so.

The truth: while a goodly amount of the stock issuance goes
to mergers and acquisitions, much also goes to fund shares
issued to pay insiders.

“When management redeems stock options, new shares are
issued to them, diluting other shareholders. A buyback is then
announced that roughly matches the size of the option
redemption. This facilitates management’s resale of the new
stock they were issued in the option redemption. Buyback? Not
really! Management compensation? Yes,” write Chris Brightman,
Vitali Kalesnik and Mark Clements of Research Affiliates, an
asset allocation and smart beta product firm. (

“Because the stock options a company issues its management
dilute the value of its stockholders’ shares, companies often
repurchase their stock to offset this dilutive effect. The net
impact is a transfer to management of more of a company’s cash
flow than is reported as compensation on the income statement.
Irrespective of the intent of the company to reduce the dilutive
impact of its options-based stock issuance with buybacks, the
reality is that the dilution is not always totally offset.”


The upshot of all of this is that while share buybacks get
much press, and often produce a bump in share prices when
announced, investors in the U.S. equity market suffered a net
dilution of 1.8 percent in 2014, or $454 billion. This net
dilution, according to Research Affiliates, is about par for the
course over the past 80 years, implying that the recent buyback
binge is not having a shareholder-friendly effect.

There is evidence that investors are waking up to these

Drug firm Johnson & Johnson announced a $10 billion
buyback plan on Tuesday, just before it released earnings that
beat street expectations. To be sure, J&J also said that a
strong dollar was hampering earnings, but the reaction has been
underwhelming, with its stock now trading more than 1 percent
below where it was before the news.

Wal-Mart on Wednesday tried to sweeten a bitter
pill, breaking news not just that it expects profits to fall 6
to 12 percent in its next fiscal year but also that it would
pursue $20 billion of buybacks over two years. Not only did its
stock fall 9.5 percent but Sterne Agee & Leach analyst Charles
Grom told clients the buyback implies contracting margins and
slow sales growth.

So now buybacks are a telltale sign of weakness, rather than
in some way being an element of shareholder returns.

BofA Merrill Lynch, in its monthly Global Fund Manager
Survey, has for a long time asked investors what they would like
to see companies do with cash flow: return it to shareholders
via buybacks and dividends; increase capital spending; or shore
up their balance sheets. The percentage of those who want to see
cash returned is low and falling, standing now at about 20
percent compared to a post-recession peak in 2010 of near 40

What managers want instead: a rising number of them favor
improved balance sheets.

The spell it seems, has been broken and investors are
looking closely not at the hand that is holding and waving a
shiny object, but at the one companies are keeping behind their
(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at and find more columns at

(Editing by James Dalgleish)

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