Value Extraction: Sucking the Life Blood Out of the Economy

I recently published a short article based on my surprise on discovering over the period of a decade S&P500 companies paid out 93% of their profits to shareholders. Some was paid as dividends, the majority as share buybacks.

With well over 10,000 views on the story, and based on comments made, it seems I was not alone in being surprised. But some commentators have said there should be no surprise in this and that it can be a smart capital allocation move.

Yes, it can make sense. If the management team have run out of ideas to put the capital to good use, they should certainly return it to investors. Upon doing so perhaps they should also quit? And isn’t such a high payout by the biggest firms in America over such a long period of time rather odd?

Investopedia, has interesting things to say about this. “Buying back, or repurchasing shares can be a sensible way for companies to use their extra cash on hand to reward shareholders and earn a better return than bank interest on those funds. However, in many cases, share buybacks are seen as just a ploy to boost reported earnings — since there are fewer shares outstanding for calculating earnings per share. Even worse, it could be a signal that the company has run out of good ideas with which to use its cash for other purposes”.

They go on to say…..

“In the wake of the 2020 global coronavirus outbreak, companies that had spent billions of dollars on share buybacks over the previous several years saw their stock prices plummet, with little cash on hand left to stem the fallout in the markets, or to pay furloughed employees. As a result, the practice of stock buybacks has again been put under the critical microscope”.

So, shining a spotlight on this issue is certainly a sensible thing to do in their opinion. And they stress, “this means that investors can’t afford to simply take buybacks at face value.”

Richard Henderson, the FT’s New York-based US capital markets correspondent, describes buybacks as a “habit” that corporates cannot kick despite the American economy having fallen into “its worst recession in decades”.

His article, published just a few days ago on July 31st, notes, “Google’s parent company Alphabet spent $6.9bn on buybacks for the quarter, up 92 per cent from a year prior”. “Microsoft, the second-largest listed US company, purchased $5.8bn of its own stock in the period, up 25 per cent from a year earlier”, and “Apple, which has spent the most on its own shares among S&P 500 companies in recent years, repurchased $16bn in the second quarter, down 6 per cent on the period last year.” Those companies really cannot find good uses for their capital? The article also includes an interesting chart.

The chart shows clear trends. Both dividends and buybacks have been increasing rapidly.

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