The trend has been hard to miss. Chipmaker Intel (INTC) bought back a whopping $10 billion of its shares on Jan. 24. Drugmaker Pfizer (PFE) purchased $5 billion of its stock Feb 1, and media giant Time Warner (TX) followed suit with its own $5 billion buyback the next day.
Companies are on a stock-buyback binge that's reaching dramatic proportions. January alone saw $57 billion in buybacks, compared with a total $357 billion for all of 2010, says Vincent Deluard, executive vice president of New York-based TrimTabs Investment Research, which tracks share buybacks. Deluard says the 2010 number was up 174% from 2009.
Dealing With Cash Flow
What's behind the surge? According to Tim Koller, a partner at consultants McKinsey & Co. and co-author of a new book called Value: The Four Cornerstones of Corporate Finance, many big firms accumulated a huge amount of cash during the financial crisis and were reluctant to spend it.
"They not only have to deal with the cash flows they're generating now," he says, "but they also have to somehow distribute the cash they generated during the crisis that they didn't distribute."
And it's not as if they aren't spending money at the same time, too. Intel bought McAfee for $7.6 billion last August.
Robert Schwartz, a finance professor at Baruch College in New York, says the decision to repurchase shares generally is "an information signal that the stock rise is unduly low and it's a good deal."
What's In It for Investors?
Generally speaking, analysts believe investors should make out the same -- whether a company pays the cash as a dividend or uses it to buy back shares. With a stock buyback, there's a mechanical effect that causes the remaining shares to rise by the amount of the repurchase.
"Companies have shifted from dividends to using share repurchases to distribute cash to shareholders," Koller says. "The reality is successful companies, once they mature, will generate a lot more cash flow than they can invest. Companies are not comfortable paying 70% to 80% of the earnings as dividends."
In addition, some large institutional investors prefer buybacks to dividends because they don't have to decide what to do with the extra money.
For the small investor, a buyback often offers more options. It means they don't have to take the benefit right away, as they do with a dividend, and pay tax on it. Long-term capital gains also pay less tax than dividends.
Koller notes that sometimes investors are concerned about what companies will do with all the excess cash they generate. "They're concerned the companies will invest it unprofitably or make acquisitions that aren't successful," he says. "In that sense, buybacks provide some confidence to investors who feel that is what the companies need to do – return that cash flow."
Mounds of Cash Sitting Overseas
Academic studies, Koller says, show companies that regularly buy back shares don't increase value any faster than companies that don't. So don't count on a newly announced buyback to send a stock higher over time. It's the company's operations that determine that.
Considering the estimated $1 trillion in cash idling on the balance sheets of S&P 500 companies, why hasn't that cash been given back? According to Koller, much of that money is sitting overseas -- and firms would face prohibitive tax bills if they brought it back to the U.S. With talk in Congress now of reforming the corporate tax structure, many businesses are waiting to see what the lawmaker come up with before bringing the money back and paying it out to investors.
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