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Cash & Working Capital

Share Buybacks Fall, Maybe for the Better

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August 24, 2017

After a surge over the last few years, companies have slowed dramatically their stock repurchases. This is good news according to some.

Mo moneyDepending on who’s doing the counting, US corporations have spent between $3-$4 trillion on stock buybacks since 2008, which has helped stock rise to new levels. But this year repurchase spend is down again, nearly 20%, according to data from Societe Generale.

And according to analysis from the INSEAD business school, this is just fine. That’s because “the more capital a business invests in buying its own stock, expressed as a ratio of capital invested in buybacks to current market capitalization, the less likely that company is to experience long-term growth in overall market value,” write researchers Robert Ayres and Michael Olenick in their report, ‘Secular Stagnation (or Corporate Suicide?).’ “We find that excessive buybacks in the past decades are a significant cause of secular stagnation, inasmuch as they effectively reduce corporate R&D while contributing, instead, to an asset bubble that creates no value.”

In other words, the economy isn’t performing at its best because companies aren’t growing as they should. The authors cite other headwinds, including increasing regulation and debt. But perhaps the main headwind is the lack of investment in companies themselves, particularly in research and development. Too much available capital is spent on buying back the company’s stock instead of on R&D.

“[I]n recent decades it appears that the classical R&D investment mechanism by corporations has been short-circuited,” Mssrs Ayres and Olnick write. “Instead, when managers have no idea how to use the firm’s profits to promote growth, they invoke the ‘shareholder value maximization’ (SVM) mantra and engage in share buybacks. The prime purpose of those buybacks seems to be to increase the wealth of top executives and short-term ‘activist’ investors such as hedge funds.”

And not only is it bad for the economy overall, ultimately it is to their long-term peril performance-wise, the two researchers note. The more cash the company dedicates to buybacks, “the less it is likely to grow, over a five year time‐scale.” They point to companies that have spent “a large fraction of their current market cap” on share repurchase and find they are “virtually guaranteed to decline in the coming years.” This includes Exxon Mobil (88.7% of market cap in buybacks), Xerox (119.2%) IBM (107.4%) and HP (271.7%).

Even though buybacks are on the decline (and have been falling over the last couple of years, unfortunately it might start to grow again. That’s because if tax reform happens, particularly a cash repatriation holiday, the cash will once again not go to R&D. According to NeuGroup peer research, a common expectation among treasurers is that much of the cash will go to share repurchases and dividends, with M&A a close third. And it’s not always the thing they want to do as activists will be gunning for the cash to be given to shareholders.

On the bright side, a presenter from a bank at one NeuGroup peer group meeting said that in a few years, companies will have more leeway. “Five years down the road, when companies no longer have trapped cash and can use overseas profits in their calculations to allocate resources, they’ll be able to think about their growth plans more holistically.”

Will this mean more R&D?

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