Companies keep buying back stock in record amounts; dividends remain the favored play, however.
Corporations kept up their torrid pace of stock buybacks in October. This coincides with record corporate debt issuance in the last month. While it’s arguable that companies are only borrowing to buy back stock (there are other uses for the money after all), that both are at record levels is telling. It also begs the question of whether borrowing to buy back stock is a good idea. The answer is not necessarily, according to market practitioners.
According to Birinyi Associates, there were $45bn in buyback authorizations in October and $453bn year-to-date. Birinyi said the amount represents a 49 percent increase in the value of authorizations vs. 2010 YTD (when there was $305bn). Corporations are currently heading toward a record $540bn of authorizations for the year, Birinyi said, which would equate to the third largest of all time (2007 saw the largest amount, $863bn followed by 2006 when there was $655bn). Much of the buyback frenzy has been fueled by growing cash piles and low interest rates.
But as noted at a recent NeuGroup Tech20 peer group meeting in early November, just because you can borrow, does not mean you should do so to buy back shares. Many market experts see this as merely stock picking if not outright gambling with cash that belongs to shareholders.
The consensus emerging from a Tech20 meeting investor panel – a panel comprised of equity and fixed income representatives – was that buyback strategies can be iffy. The fixed income investor was of the view that borrowing to buy back shares was not a good idea as it doesn’t add any long-term value. Nor did the equity investor favor buybacks. His view was that buybacks were not a good under any scenario let alone borrowing to do it. The only way investors might view it as a positive is if it is beneficial over their own planned investor horizon. And even in this case it can only work for so long.
Another scenario where buybacks might work for a time is if a company is significantly underleveraged. In any case, simply borrowing because money is cheap will not win favor with investors on the equity side because they will always be concerned that the company will do something with the proceeds that does not create value.
Both investors said they preferred dividends over buybacks, although on the equity side, investors want to know precisely what is going on with excess cash, regardless of what’s done with it. But the good news for these investors was that Tech20 member companies lean toward dividends. Several members were able to consistently offer dividends and yet still maintain the revenue ramping and margins of a growth company.