Stock Buybacks — An Economic Bonfire of the Vanities
In 2019 we as a nation took a trillion dollars out to the parking lot and set it on fire. We will be doing the same if not more in 2020. We could have used that to pay down student debt, begin converting to a fully renewable energy supply or just to repair our long neglected and crumbling infrastructure. None of those alternatives were ever considered. We just threw the money away. The shovels and matches we used for our national wealth disposal project were share buybacks.
That’s not the official story, it’s just reality. The official story is either we “returned the money to shareholders” or “we used it to enrich the compensation of corporate executives.” Both of those are not just said, but strongly believed by large numbers of “informed” observers. I’m afraid those are just stories we tell. As a matter of business or economic reality, it’s basically nonsense.
The idea behind all this is that reducing the corporate share count while maintaining earnings will boost Earnings Per Share (EPS.) As long as the Price/Earnings (PE) ratio stays constant that means the price per share will go up. That’s the bet placed on the big roulette wheel in the great financial casino in the sky. We put our money on “black” and then spin the wheel. At its heart, it’s not a business strategy it’s a gambling strategy.
I spent 35 years in IBM and over 20 years as VP Corporate Strategy. Part of my job included briefing financial analysts on our strategies. IBM was and remains a heavy user of stock buybacks and I fielded a lot of questions over the years on the topic. For a time, I was also a direct and personal beneficiary of the practice. I’m quite knowledgeable on the topic and for those with a penchant towards blame I freely admit my complicity.
In the early days I would respond to questions with something like “at the current stock price IBM sees this as a good investment.” Later that would change to “IBM has two major tools to return money to shareholders, dividends and buybacks. Some investors prefer the former while some the latter and IBM serves both.” I was not alone. My counterparts both in IBM and across the market all echoed the exact same refrain. Most of us believed it, at least at some level. Investors did too and began expecting and then demanding the practice. The gamblers all agreed this was a good gambling strategy. Keep putting that money on the roulette wheel!
To meet these expectations, IBM established and published a clear EPS roadmap. Initially that roadmap was built by first laying out operational plans and then layering in a set of financial plans, including buybacks, to serve as contingencies if the operational plans fell short. Over time those two flipped. The financial plans, specifically buybacks, came first and began squeezing out operational investments. We eventually reached the point where leadership proclaimed that our financial manipulations were the strategy. At some perverse level the gambling strategy had become the corporate strategy.
None of those latter stages were really admitted publicly, but it was visible to careful observers. Analysts began making noise about the “quality” of IBM earnings. And, then that great roulette wheel in the sky began hitting double zeros and red on a regular basis. IBM’s PE ratio began compressing right in line with its buybacks.
That wasn’t bad luck. It’s the reality of what happens as the balance sheet gets steadily drained by a gambling addiction. While the exact details differ, the same story has been unfolding across corporate America for decades. There are many, many companies who are paying out more in dividends and buybacks than they make in earnings. In a truly sad story of corporate gambling addiction the formerly great and financially sophisticated GE found itself taking out loans to support their gambling (buy-back) addiction. As every gambler eventually learns to their dismay, the house always ends up winning in the long run.
Most companies have maintained their “returning money to shareholders” story. Some will add something along the lines of “we see no better use for the money.” Since they’re just throwing the money away it means they have no use for the money, and that’s probably the most accurate description of what’s going on. It’s not that they lack ideas. I’ve spent countless hours working with corporations on their innovation programs and never encountered one that didn’t have good ideas. Modern corporations are not lacking in either intellectual or financial capital. The shortfalls come in the form of management bandwidth and other forms of human capital. The limits are people, not capital and certainly not taxes.
That’s the longer version of the story. Here’s the short and simple one. Imagine two people sitting across the table from each other. One is holding one trillion dollars in stock, while the other is holding one trillion dollars in cash. Together they have two trillion in wealth. Now they trade. One gets the trillion in cash. The other gets the trillion in stock and proceeds to destroy it, to remove it from the table. Afterwards, the person who originally held a trillion in cash is now sitting with nothing. That trillion in cash came off their balance sheet and, as far as they’re concerned, is simply gone. Between the two of them they now hold only one trillion in wealth. That’s what we’re doing as a nation every year and it’s getting worse.
Like any addict, corporate America is in need of an intervention. Some family member or close friend needs to pull them aside and explain that putting money on the roulette wheel in the financial casino is no different than taking it out to the parking lot and setting in on fire. And, since these businesses truly have no idea what to do with all their money, we need to ask our conservative friends why they keep wanting to add to the bonfire rather than putting our country to work building all the things we need and have been neglecting. That $1 trillion in buybacks is prima facie evidence that we can raise business taxes by at least that amount and not cause any negative impact to real economic output.
There really, truly, are better things our nation can do with a trillion dollars every year.
