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Companies Use 60 Percent Of Profits On Stock Buybacks. What Are They?

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Companies Use 60 Percent Of Profits On Stock Buybacks. What Are They?
It was illegal until 1982, but now it's becoming more common for companies to buy back stocks.
SHOW TRANSCRIPT

Stock buybacks are popular. They have been for a while, driven by hefty corporate profits and more recently by President Trump's $1.5 trillion federal tax cut. But what are they?

Also known as a "share repurchase," they're basically a company buying shares of its own stock. They were illegal until 1982.

Two buyback options exist. A tender offer is when a company offers to buy a certain number of shares within a given time frame, and usually at a figure that's higher than the market price. An open market buyback is more common. The company buys shares on the open market at the going rate, just like any investor would.

We'll focus on the open market option, which typically happens when a company has extra cash on hand because of strong profits or tax breaks — or both, as it were in 2018. There's a strategy when it comes to buybacks, instead of just paying dividends. 

Management might think the stock is undervalued and a repurchase shows confidence in its own future. Then the biggie: It's a great way to reward shareholders by returning wealth to them. As the company buys stocks off the market, the remaining ones held by investors become more valuable. 

Here's an example, with some help from Investopedia: Let's suppose a company has $2,000,000 in earnings and 10,000,000 shares of stock on the market. The earnings per share would be 20 cents. If the company buys back a million shares, that would leave 9,000,000 on the market. That bumps the earnings per share up to 22 cents. 

Higher earnings per share can drive the stock price up, which could last a day or a decade. Critics of buybacks have some other ideas for those dollars. 

Two key findings from a 2018 study out of the Roosevelt Institute:U.S. companies spent almost 60 percent of their profits on buybacks, leaving less money for corporate investment, job creation and raising wages.Public companies in the restaurant [136.5%], retail [79.2%] and food manufacturing [58.2%] industries — "employers of many of America's low-wage workers, who are disproportionately women and people of color" — all spent more than half of net profits on buybacks.

One thing to consider: Buyback proponents say those who invested originally should reap the financial reward. Plus, shareholders reinvest the money in other companies — sometimes younger, smaller ventures that are expanding and hiring.  

So when it comes to buybacks, it seems value is in the eye of the job holder, or stockholder.