让我们看看两家公司的情况，一家名为Superb Steward Corp.，另一家是Lacking, Inc.。它们都有标普500指数成分股公司那样的规模——总股本10亿股，市值500亿美元，股价均为50美元。去年两家公司均盈利25亿美元，则每股收益都是2.50美元，市盈率均为20倍。两公司都将40%的利润用于分红，区别在于Superb Steward将另外30%利润通过回购回馈给了股东，保留了30%的利润。Lacking则将未分红盈利，也就是全部60%利润用于再投资。
对它们以及整个股市来说，资本成本，或者说投资者可以从风险水平相当的股票和债券中得到的有竞争力的回报率为5%，这是“实际水平”，也就是剔除了通胀影响的回报率（相当于20倍市盈率的倒数）。加上2%的通胀率，投资者预期的总回报率为7%。大家也许已经想到了，Superb Steward在分配利润方面做得非常好。它用于再投资的30%收益实现了5%的增长，有竞争力，而且它意识到无法为另外30%利润找到可盈利的投资目标。这样，Superb Steward每年的利润增速为3.5%（30%的利润获利5%，增幅为1.5%，再加上2%的通胀率）。它的分红增速为2%，另外回购1.5%的股票（25亿美元利润的30%为7500万美元，占其500亿美元市值的1.5%）。六年后，也就是到2026年初，Superb Steward的总利润将增长23%（每年增3.5%），达到30.8亿美元，而股本将减少9%左右，降至9.13亿股（每年因回购减少1.5%）。在二者共同作用下，Superb Steward的每股收益将升至3.37美元，保持20倍市盈率不变，其股价将上涨35%，从50美元升至67.40美元。
Superb Steward的每股收益和股价增速是Lacking的两倍，一个是35%，另一个是17%。到2025年初，Superb Steward的股价将比Lacking高16%以上。从现在到2025年这段时间里，Superb Steward CEO展现出的水平，也就是保留利润，只在回报率高时才动用所带来的期权和限售股要比Lacking那位“烧利润”大户多好几百万股。
The forces battling against share buybacks have a powerful new ally: The Securities and Exchange Commission. In the past few weeks,team of progressive Senators Bernie Sanders (I-Vt) and Chuck Schumer (D-NY) have locked arms with normally pro-business Republican Marco Rubio of Florida to denounce the boom in repurchases for killing jobs and spreading income inequality. Now, Senator Chris Van Hollen (D-Md) is claiming that America’s CEOs and other top executives are abusing buybacks to dump shares at inflated prices.
In December, Van Hollen requested that the SEC review whether insiders are deploying repurchases to boost their compensation instead of using those dollars to make the investments that strengthen their companies and create new jobs. In a March 6 letter to Van Hollen, SEC chairman Robert J. Jackson wrote that the agency had performed an extensive study revealing that when companies announce buybacks, an unusually large number of executives sell shares in the days that follow. Jackson noted that a buyback announcement signals that management believes its shares are too cheap, causing stocks to rally, on average, by about 2.5% in the days that follow. Executives, says Jackson, pounce on that bounce to sell shares. “That creates the risk that insiders’ own interests––rather than the long-term needs of investors, employees and communities––are driving buybacks,” wrote Jackson.
The Van Hollen letter isn’t the first time Jackson skewered repurchases. In a June speech on the topic, Jackson questioned whether boards and CEOs are choosing buybacks because they’re “the right thing to do with the company’s capital,” or instead to “pocket some cash at the expense of shareholders.” For Jackson, buybacks are guilty of nothing less than “breaking the pay-performance link.”
Surprisingly, the SEC study found that while top managers apparently orchestrate, and benefit from, a short-term pop to cash out, the gains quickly reverse: Ninety-days after the announcement, the company’s shares underperform the market on average by 8%.
It may be sound policy for the SEC to restrict insiders’ freedom to sell shares right after a buyback announcement. But the crucial issue is whether the SEC will join bi-partisan buyback foes in Congress, and move to impose new restrictions on repurchases. It’s possible. Chairman Jackson is now taking the position that CEOs are likely making crucial decisions on whether to reinvest in the business or return cash to shareholders based not on what’s best for the company, but on boosting their own pay.
That view is questionable. CEOs and other top managers get most of their comp in equity awards, chiefly restricted shares and stock options. Those grants typically vest over four or more years. C-suite executives might have an incentive to cash out using buybacks that deliver a quick bump, but weaken the enterprise and depress the share price in the years to come, if they held––and were systematically selling––a lot more unrestricted stock than they hold in equity awards they’ll collect in the future. The SEC letter to Van Hollen does not cite the dollar amounts of the buyback-related insider sales for individual executives, or compare them to the trove they’re still holding, either in unvested awards or in unrestricted accounts.
If indeed CEOs can get richer by raising the value of their shares in the next five or six years than cashing on an ephemeral spike by pushing buybacks, then they should be deploying capital where it achieves the highest possible returns, at least over the medium-term. And that’s a strong possibility that Congress and the SEC should consider before restricting repurchases, a policy that risks damaging unintended consequences.
For CEOs and their lieutenants, the principal lever for raising the stock price is growing earnings-per-share. Dominating the U.S. economy are mature behemoths in steel, autos and packaged goods that generate far more profits than they can profitably reinvest in new plants, warehouses, fabs, or labs-––even such formerly go-go names as Apple and Microsoft now fit this profile. Here’s why these stalwarts, and many other players that need to make tough choices between reinvestment and repurchases, have a powerful incentive to return cash to shareholders: If a company reinvests a big portion of profits at less than competitive returns, say in pokey old-line businesses or expensive acquisitions, earnings-per-share will badly lag what EPS would have been if the cash had gone to shareholders in dividends, or the new favorite, buybacks. And once again, it’s rising EPS that drives share prices, and wins CEOs a bonanza on their options and restricted stock.
Put simply, buybacks per se don’t raise EPS or share prices, but not returning cash can be a killer.
Let’s look at two companies that we’ll call Superb Steward Corp. and Lacking, Inc. Each is a typical S&P 500-sized outfit, with 1 billion shares outstanding, a market cap of $50 billion, and a share price of $50. Both earned $2.5 billion last year, so EPS is $2.50, and they share a P/E multiple of 20. Each pays out 40% of its earnings in dividends. The difference is that Steward distributes another 30% of profits in buybacks, and retains the remaining 30%. Lacking reinvests all of the earnings not paid in dividends, or 60% of the total.
For each company, and the stock market as a whole, the cost-of-capital, or the competitive return investors could garner from equally risky stocks and bonds, is 5% “real” or adjusted for inflation (equivalent to the inverse of the 20 P/E). Add 2 points for inflation, and investors expect a 7% total return. As you probably guessed, Superb Steward does a great job in allocating profits. It makes a competitive 5% gains on the 30% of earnings it reinvests, and recognizes that it can’t find profitable places to park the other 30%. So each year, its profits rise by 3.5% (30% reinvested earnings at 5%, or 1.5%, plus 2% inflation), it delivers 2% in dividends, and repurchases another 1.5% of its shares (30% of $2.5 billion in earnings are $750 million or 1.5% of its $50 billion market cap). In six years, by early 2026, its total earnings will grow by 23% (3.5% per annum) to $3.08 billion, its share count will fall by around 9% to 913 million shares (shrinking 1.5% a year due to the buybacks). The combination will lift its EPS to $3.37, and its share price by 35%, from $50 to $67.40 at the steady multiple of 20.
By the way, if Steward had found good places to invest the 30% of profits it returned in buybacks, the result would be exactly the same. That’s why buybacks per se don’t raise EPS and stock prices. The extra profits from the reinvested earnings would have exactly compensated for leaving the share count constant at 1 billion.
By contrast, Lacking thinks it’s found great places to plow all of the 60% of profits-after-dividends into its basic business. But Lacking is an aging stalwart that suffers from hubris. Its corporate culture relishes building new factories in plodding bedrock industries, and bulking up on mergers. Lacking’s CEO is an empire builder who prizes size above all else. As a result, Lacking generates only a 1% real return on those reinvested profits, still positive, but far below the 5% market minimum. Over the next six years, Lacking will delver profit growth of 2.6% a year (60% of earnings x real return of 1% = .6%, plus 2% inflation), so that by 2024, its earnings will wax by 16.6% from $2.5 billion to $2.9 billion. Its EPS will be $2.90 (because it still will have the same 1 billion shares outstanding). And its share price will be $58.00 at the same 20 multiple.
Steward grew its EPS and share price at twice the rate of Lacking, 35% versus 17%. By early 2025, Steward’s shares would be over 16% more valuable than Lacking’s. Flipping the calendar to 2025, the skill Steward’s CEO displayed in keeping profits in-house only when they generated good returns delivered many more millions in gains on options and restricted stock than the earnings-burning grandee garnered at Lacking.
Which strategy, hoarding capital or paying it out, was better for the overall economy? Over our six year window, Steward reinvested $5 billion of its earnings in businesses that grew briskly, created jobs, and generated strong returns. It handed another $5 billion back to shareholders. In turn, pension funds, endowments, and individuals had the freedom to funnel those funds into the fast-growing, cash-hungry businesses––the Apples and Amazons of the future––that deliver competitive returns on new capital, and create lots of jobs.
Lacking tied up $10 billion, all of its non-dividend profits, in ventures that barely grow with inflation, and probably shed jobs. Memo to the SEC: An unfettered financial market may be the best machine for channeling capital to the highest and best uses. And for lawmakers and regulators, the right solution may be keeping their hands off the gears.