Stock Buybacks and Dividends Become a $1.5 Trillion Political Target

Despite volatile stock markets and a slowing economy, U.S. companies are sending more money to shareholders than ever before.

The amounts are staggering, which is why these huge sums, sometimes called “windfall profits,” are political targets.

The groundbreaking climate and tax legislation that required President Biden’s signature includes, for example, a new 1% tax on buybacks.

senator Chuck Schumer, New York Democrats and Senate Majority leaders announced the new tax in a terse critique. “I think it’s one of the most selfish things corporate America does.”

Still, buybacks and dividends are very important to investors.

S&P 500 companies expect to spend more than $500 billion on dividends and more than $1 trillion on share buybacks this year, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. please give me. That’s a combined $1.5 trillion, more than ever.

No wonder this huge cash flow is getting so much attention.

As an investor, consumer, or just a citizen of the planet, it’s worth considering the importance of buybacks and dividends. Aswas Damodaransuggests a professor of finance at New York University.

“It’s really a question of price and value,” he said in an interview. It’s bad when it’s done in a detrimental way.It’s all about the numbers.”

Windfall vs. Steady Profits

Windfall profits from energy companies are boosting total buyouts and dividends.

ConocoPhillips Earlier this month, the company announced that it would “increase its planned capital return in 2022 by $5 billion to $15 billion,” thanks to a special dividend. EOG resource made a similar move, declaring a special dividend of $1.50 per share, doubling its regular quarterly dividend. Exxon Mobil is dividendit will spend $30 billion on buybacks, triple the previous total.

From a classical economic standpoint, this year’s huge gains for energy companies are to be expected from a sudden shock to overall supply, largely due to Russia’s war with Ukraine and Western sanctions. Thing. Companies that extract, refine, and distribute oil and gas make huge profits. The S&P 500 has fallen this year, but energy companies are up more than 40%, far higher than any other sector, according to FactSet.

moral dilemma

If you own shares in broader stock index funds, you own some of these companies and they enhance their own returns. Financially, it’s great.

But is it immoral?

UN Secretary-General Antonio Guterres says yes. “Oil and gas companies are making record profits from this energy crisis and paying a huge price to the climate, shouldering the poorest people and communities,” Guterres told reporters at the United Nations headquarters in New York. It’s immoral,” he said. August 3.

Similarly, President Biden said in June:Exxon We made more money than God this year,” he said, criticizing the company for its plans to spend $30 billion on stock buybacks instead of investing in oil drilling capex. The company does both, and says share buybacks are a good thing for investors.

All of these companies are under government and shareholder pressure to move to greener fuels. And many should be moving faster. But the world still needs the energy they sell, so they and their shareholders make a profit.

Consider an American company that was cash-rich enough to lead the market in share buybacks for the 12 months ending in June. There were no energy companies. According to the S&P Dow Jones Indices, Apple topped the list with $91.3 billion in buybacks. Other top performers were Alphabet (Google’s parent company), Meta Platforms (which owns Facebook), Microsoft and Bank of America.

“Companies like Microsoft and Apple have windfall profits year after year. Yun Yu Ma, Chief Investment Strategist at BMO Wealth Management in the United States. “But we don’t hear much about taxing their ‘accidental’ profits.”

dividend yield

Modern dividend-paying companies are sometimes considered Steady Eddies, reliable providers of steady income.

Among them are Caterpillar, Clorox, Coca-Cola, Colgate-Palmolive, T. Rowe Price, and Chevron and Exxon.

“People tend to forget about dividends when the market is up 20% a year,” John Linehan, portfolio manager at T. Rowe Price’s Equity Income Fund, said in an interview. “But the longer the investment horizon, the more important the dividend.”

That’s evident when looking at the returns calculated by Silverblatt. From 1926 until June he averaged 3.5% of the S&P 500’s average yield, which is nearly double its current rate, but by his calculations, dividends accounted for his 38.2% of the index’s total return. was

Measuring the effectiveness of buybacks is trickier. Buybacks are often said to increase stock value by reducing the number of shares, thereby increasing earnings per share. Also, much of the recent rise in the stock market is said to be due to share buybacks. But the evidence is more complicated.

unintended consequences

“Few people know that for years after the 1929 Crash, the Securities and Exchange Commission (SEC) viewed share buybacks as bordering on criminal activity,” said Yardeni Research, an independent firm. Edward Yardeni and Joseph Abbott of , “Share Buybacks: The True Story”.

The authors say the increase in share buybacks is part of an unintended consequence of tax law reforms in 1993 under President Bill Clinton that imposed a $1 million cap on chief executive salaries. increase. Companies have been creative, accelerating the issuance of stock options and grants as a form of executive compensation.

As The New York Times has documented over the years, such subsidies widened the pay gap with the rank and file and created millionaires in the executive suite.

Issuing shares to corporate officers and general employees in this way dilutes existing shareholders’ shares. For example, you own 1 of his 100 shares in a small company. After her 10 new shares are issued to an employee of the company, she can only own 1/110 of the company.

However, the company is correcting that dilution with a share buyback. This will prevent the stock from depreciating in value. As the buyback grows, reducing the total number of shares to say 90 increases the value of the shares.

research by city ​​research The S&P 500 companies made a total of $882 billion in buybacks last year, leaving only $620 billion in buybacks after processing equity dilution. Only that part can be reasonably explained as the return of value to shareholders.

The impact of share buybacks on stock prices is ambiguous. The largest buyback stocks in the S&P 500 index outperformed the overall S&P 500 in the decade ending July, but underperformed the overall S&P 500 in the five years. If these purchases are actually boosting stock returns, the numbers don’t conclusively show it.

Shareholders are better off when companies can reinvest their money more productively without it Dividend or buyback.

Warren Buffett explained this to Berkshire Hathaway shareholders. “Our shareholders are much wealthier than they would have been if the money we had spent on acquisitions had instead been used for share buybacks and dividends,” he said. I have written In a letter to shareholders in 2012.

He buys shares in companies that pay dividends for Berkshire, but Berkshire itself doesn’t pay dividends. Berkshire buys back Buffett’s shares if he finds the price a bargain (which he does these days). If you buy stocks when the stock price is too high, you lose value.

This is the core of financial theory. There is an art in making practical decisions, not just enriching executives.

From this perspective, buybacks and special dividends are excellent uses of a company’s cash when the windfall gains are not accompanied by an attractive opportunity to reinvest the company.

Ma said the new 1% tax could shift some corporate spending away from share buybacks to dividends. However, dividends and share buybacks will continue to be important ways for companies to return profits to shareholders.

If you need to withdraw it now, it is very important whether the money arrives steadily or as a windfall.

But fundamentally, a company’s ability to generate large amounts of cash is important. As long as you have a lot of it, and as long as it is compounded over a long period of time, you will thrive.

Unexpected profit? Do it as often and as often as possible.