Corporate America is flush with cash and has bought back a near-record number of shares this year. President Biden wants to increase taxes on these buybacks. Biden will reportedly propose in his State of the Union speech tonight to raise the tax that companies pay when they buy back their own stock from 1% to 4%. The theory is that imposing additional taxes on buybacks will encourage companies to invest in hiring more people or making capital expenditures (more plants, buildings or technology) rather than buying back their own shares. While the validity of this theory is debatable, there is no doubt that companies appear to be on a buyback spree. Many observers expect that 2024 could be a near-record year for buybacks. Why Buybacks Are Rising After a record 2022 that saw $950 billion worth of stock repurchases, 2023 was disappointing, largely due to a lack of earnings growth. But 2024 and 2025 look like near-record years. Buybacks: gaining momentum? (repurchases completed) 2024 (estimated) $925 billion 2023 $815. 2022 $950 b. 2021 $919 b. 2020 $538 b. 2019 $749 b. Source: Goldman Sachs Jeffrey Yale Rubin of Biriny Associates estimates that companies announced $187 billion in buybacks in February alone, second only to the record $225 billion announced in February 2022. and political uncertainty will be a headwind,” Goldman Sachs said in a recent report. Goldman recently raised its share repurchase forecast for 2024 to $925 billion (up 13% year-over-year) and $1.075 trillion in 2025 (up 16% year-over-year). Goldman noted that a significant portion of the buybacks are driven by record earnings in large technology companies: “We expect the increase in buybacks in 2024 to be driven primarily by mega-cap technology stocks,” the bank said. Indeed, Goldman noted that the Magnificent Seven accounted for 26% of S&P 500 buybacks in 2023. Corporations prefer stock buybacks. Corporate America has wide discretion over what it does with the cash flow it generates. Excess cash typically falls into three groups: buybacks, dividends, and capital expenditures. While the percentage that goes into each basket goes up and down, companies have recently shown a greater propensity to repurchase shares. 2023: What has corporate America done with its cash flow? Buybacks $765 billion. Capital expenditures $597 b. Dividends $588 b. Source: S&P Global Reason: Buybacks can boost stock prices because they reduce the number of shares outstanding and, in theory, boost earnings per share. Of course, dividends are an alternative source of returning money to shareholders. And big tech companies may be moving in that direction. At the same time, Instagram parent Meta Platforms announced a recent share buyback and announced its first dividend. Three of the Magnificent Seven (Alphabet, Amazon and Tesla) do not pay dividends. Goldman found that large companies with stable earnings, high profitability and low share prices are most likely to initiate dividend payments. Using this framework, they noted that Alphabet and Amazon, respectively, were the 1st and 8th stocks in the Russell 3000 index most likely to start paying dividends. The allocation of funds for capital investments and hiring of employees is an open question. It’s possible that companies will use free cash to increase capital expenditures and ramp up hiring if buyback taxes rise, but at least for large-cap tech stocks, the decision will likely be driven by the state of tech growth, and not tax evasion. The Magnificent Seven spent $407 billion on capital expenditures and research and development in 2023, representing 23% of their annual revenue and 27% of all S&P 500 capital expenditures and R&D spending. “If management teams see attractive investment opportunities beyond these rising costs, they may limit the growth of buyback programs to fund investments,” Goldman said. In other countries, decisions to invest in a given area largely come down to economic growth: higher growth means companies will be more willing to invest in hiring more people and capital expenditures. Goldman noted that its economics teams expect economic growth to slow in the second half of 2024, suggesting investors will continue to favor companies that return cash to shareholders. “However, if economic growth momentum continues to build, investors may increasingly reward companies that invest in growth,” Goldman said. Will higher taxes dissuade companies from buybacks? In early February, Meta authorized an expanded $50 billion share repurchase program, equivalent to about 5% of shares outstanding at the time. Under the current tax, the company would pay $500 million; under Biden’s proposed tax, it would rise to $2 billion. This is a significant amount of money, but it is unclear whether this will force Meta to redirect money from the buyout to capital expenditures. “I haven’t seen anything to suggest that taxing buybacks will force corporations to redirect cash toward capital expenditures,” Howard Silverblatt, senior index analyst at S&P Global, told me. Silverblatt echoed Goldman’s analysis, noting that corporations would rationally decide to spend more money on hiring and capital expenditures if the economy continued to grow: “That’s what they should do, go where the growth is,” he told me.
