The recent increase in share buybacks has seen vast sums of cash returned to investors. However, as Emma Cusworth finds, there is more to it than meets the eye.
“We are seeing new records set year after year with more money spent on buybacks than dividends in the S&P 500.”
Bryon Lake
Share buybacks have surged as companies pass some of their vast cash mountains, accumulated as the confidence for capital expenditure all but died in the wake of the financial crisis, to investors. Although this returning of capital is generally seen as shareholder-friendly, it can also be a shareholder foe.
Since the dividend and capital gains tax rates were cut to 15% in the US in 2003, the popularity of share repurchases has rocketed. Having remained relatively stable until that point at around $30bn per quarter, according to data from S&P Dow Jones Indices, between Q2 of 2003 and the end of Q3 of 2007, the dollar value of quarterly share repurchases increased six-fold from $28.4bn for the S&P 500 to just under $172bn. Following the crisis, buybacks fell back dramatically, recording a low of $24.2bn at the end of Q3 2009, but have since regained momentum, reaching $553.2bn for 2014, according to S&P estimates.
The growth in buybacks has been a consistent theme, particularly in the US, where Bryon Lake, head of Invesco PowerShares EMEA, says: “We are seeing new records set year after year with more money spent on buybacks than dividends in the S&P 500.”
The US is by far the largest market for buybacks, with activity at much lower levels in other markets such as Europe, Japan and the UK, but the impact of US buybacks should not be underestimated for international investors. The vast majority of the largest global companies, including names like Apple, Exxon Mobile and General Electric are based in the US but make up a significant proportion of some of the most popular global indices.
Those three companies alone, all of whom have significant buyback programmes in place, represent more than 4% of the MSCI World, for example, which is nearly 57% weighted to the US. They also make up nearly 4% of the FTSE All World index.
FAT UNDER THE SKIN
The increase in the level of buybacks reflects the growing cash mountains sitting on corporate balance sheets in a world where corporate confidence is building, especially in the US.
“As a result of the crisis, everyone was worried about spending cash,” says JLT Employee Benefits investment consultant Maria Nazarova-Doyle. “Companies were stockpiling so there is a lot of fat under the skin.”
In some cases, the amount of cash sitting on corporate balance sheets is extreme. Apple Inc, for example, is sitting on a cash mountain of around $200bn (not far off Ireland’s GDP of $232bn in 2013, and that’s just Apple’s cash). The company announced in April it would be adding another $50bn to its buyback programme, taking the total to $149bn over the next year.
The total cash sitting the balance sheets of US corporations is estimated to be around $3trn, which, according to The Boston Company Asset Management, is an all time high. “This represents around 14% of assets, up from a low of about 8.5% a decade ago,” says Brian Ferguson, senior managing director.
Companies have two ways of returning these reserves to shareholders – dividends and buybacks. Buybacks are attractive to corporates not only because they counteract the dilutive effect of executives, share options, but also because they offer greater flexibility than dividends, where cuts are often perceived by the market as a red flag.
“With buybacks there is no such inverse relationship,” says Lake. And, from the investors’ perspective, the tax treatment of buybacks is often preferable to that of dividends.
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