Why Apple, Warren Buffett, And Others Use Stock Buybacks

Summary

The 2017 tax reform, which reduced the corporate tax rate to 21%, was intended to encourage companies to reinvest profits into research, capital expenditures, and job creation. However, many corporations instead opted for record-breaking stock buybacks, worth $1.1 trillion, leading to debates among politicians about the need for legislation to prioritize worker benefits over buybacks. Critics argue that buybacks are financially engineered to mask poor business performance and benefit executives rather than shareholders, while proponents believe they signal strong cash flow and boost stock prices.

Takeaways

• 📉 The 2017 tax reform aimed to encourage corporations to reinvest profits into research and employee wages to create new jobs, but also resulted in a significant corporate tax cut.
• 💼 The tax reform lowered the corporate tax rate from 35% to 21%, with the expectation that companies would increase capital expenditures, including physical equipment, offices, factories, and intellectual property.
• 📈 Initial business spending in 2018 showed a 19% increase over 2017, with R&D spending up by 14%, indicating some positive impact from the tax reform.
• 📉 However, business investment slowed later in the year due to growing economic concerns, and companies announced a record $1.1 trillion in stock buybacks.
• 🤔 The debate over stock buybacks has been contentious, with politicians considering legislation to encourage companies to invest in workers before engaging in buybacks.
• 🏛 Senators Chuck Schumer and Bernie Sanders proposed legislation to set minimum requirements for worker investment as a precondition for share buyback plans.
• 📊 Republican Senator Marco Rubio suggested raising the capital gains rate to discourage buybacks, highlighting the political divide on this issue.
• 💡 Stock buybacks can be a sign of a company's financial health and good cash flow, but they are not always indicative of overall performance.
• 📊 Critics argue that buybacks are a form of financial engineering that does not improve the business and can mask underlying financial issues.
• 🚀 Buybacks can temporarily boost a stock's price by reducing the number of shares outstanding, potentially increasing earnings per share.
• 💼 The timing of buybacks is often poor, with companies sometimes purchasing shares at higher prices than necessary, which can be a significant issue.
• 🤝 Some politicians and regulators are considering new rules or changes to discourage buybacks, suggesting they may benefit executives more than shareholders.

Q & A

What were the main objectives of the tax reform measures passed in 2017?

The main objectives of the 2017 tax reform were to spur corporations to reinvest profits into research, pay their employees, and create new jobs. It aimed to achieve this by providing a significant tax cut, lowering the corporate tax rate from 35 percent to 21 percent, and encouraging capital expenditures.

How did businesses initially respond to the tax reform in terms of spending?

In the first half of 2018, businesses increased their spending significantly. Business spending reached $341 billion, a 19 percent increase over 2017, and research and development spending hit $147 billion, a 14 percent increase.

What trend was observed in business investment later in 2018?

Business investment slowed later in the year as concerns about the economy grew. This was concurrent with companies announcing a record $1.1 trillion worth of their own stock buybacks.

What is the controversy surrounding stock buybacks?

The controversy lies in the fact that while stock buybacks can boost a company's stock price and earnings per share, critics argue that they are a form of financial engineering that does not improve the business fundamentally and can mask deeper issues within a company.

What legislative actions have been proposed in response to stock buybacks?

Senators Chuck Schumer and Bernie Sanders pledged to introduce legislation that would encourage companies to invest in workers before buying back stock, setting minimum requirements for worker investment as a precondition for share buyback plans. Senator Marco Rubio suggested raising the rate on capital gains to discourage buybacks.

What are the potential negative implications of stock buybacks for a company's financial health?

Stock buybacks can be detrimental if a company is wasting the money it needs to survive on buybacks or spending money it doesn't have, which can be as fruitless as repurchasing its stock at a bottom.

How do stock buybacks affect a company's earnings per share?

When a company buys back shares, it reduces the number of shares outstanding. If profitability remains the same, this action will increase the company's earnings per share.

What is the tax implication of stock buybacks compared to dividends?

Buybacks are generally taxed at the capital gains rate, which is typically lower than the income tax rate applied to dividends, especially if the stock is owned beyond one year.

What does the criticism suggest about the timing of share repurchases by companies?

Critics argue that companies are notoriously bad at timing the repurchase of shares, often ending up paying more for shares than they should, which can be a significant problem.

What is the potential conflict of interest regarding stock buybacks and company executives?

The potential conflict arises when executives sell their shares into the buyback, which can suggest to the market that the stock is cheap, while they themselves are selling, raising questions about the true value and intentions behind the buyback.

What are some of the proposed solutions to address concerns about stock buybacks?

Some proposed solutions include eliminating the 1982 regulatory change that enabled large buybacks, tying buybacks to a $15 minimum wage and improved worker benefits, tweaking the tax code to eliminate incentives for buybacks, and opening a comment period on rules for stock buybacks.