The ‘good news, bad news’ behind stock buybacks

Mar 9, 2015
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The ‘good news, bad news’ behind stock buybacks

Mar 9, 2015
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General Motors has about $25 billion in cash, and on Monday, it announced it’ll send $5 billion of that to shareholders by buying back stocks; it’ll send another $5 billion back to investors by paying out more in dividends. 

Why? 

Well, it’s got to do something with extra cash. Some investors argue: Why not give it to us?

“Companies have been hoarding cash ever since the financial crisis, and one main reason for this is companies are spooked,” says Damien Park, managing partner of Hedge Fund Solutions. “As a result, there is more cash on corporate balance sheets today than ever before.” 

Large piles of cash tend to invite some investors to complain — loudly.  They might say they aren’t getting enough return on their investment, or that the company’s not spending wisely. In General Motors’ case, one hedge fund backed investor Harry J. Wilson, who was preparing to acquire a seat on GM’s board of directors to push his agenda for returning cash to shareholders.   

“One of the ways the company responds to this,” says Steven Davidoff Solomon, professor of law at UC Berkeley School of Law, “is to say, ‘Look, we’re trying to help our shareholders, we’ll give them back some cash.’” 

In a nutshell: Please shut up and here’s some money.

The stock buyback has several advantages. It reduces the number of shares floating around, and so each remaining share becomes more valuable in principal. 

“Buybacks boost earnings per share and so … you can get a better stock price,” says Hedge Fund Solutions’ Damien Park.  

Returning money to shareholders via buybacks is often preferred over dividends. Dividends are taxed twice, once as income for the company, and again as income for the individual receiving the dividend. Moreover, once a company commits to boosting dividends, if there is ever a time in the future when the company wants to return dividends to previous levels, investors will view it very negatively.

The downside of using cash to buy back stocks is … you’re using cash to buy back stocks.  

“The other angle on this is that companies could be doing other things with the cash,” says Ed Clissold, U.S. Market Strategist at Ned Davis Research. Like saving it for the next economic crisis or spending it to grow the company, “…expanding their plants, hiring more workers, paying them more and filtering it through to the economy.”

In a sluggish economy firms may not see growth as possible. Thus buybacks are a vote, says Clissold, that a company doesn’t see many opportunities out there to invest in. 

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