Corporations bet on themselves by making strategic decisions that are aimed at increasing the company’s value over the long term. This may involve taking calculated risks and investing in new initiatives that have the potential to generate future growth and profits, even if there is some uncertainty or risk involved in the short term.
One common way corporations can bet on themselves is through share buybacks, in which the company purchases its own shares on the open market. This can be a way for the company to demonstrate confidence in its own future growth prospects, as well as a way to return cash to shareholders.
Recently, four mega corporations have been buying their own stock: Apple, Microsoft, Meta, and Alphabet.
It is important to note that 2022 was a big year when many companies purchased shares of their own shares due to a change in corporate taxation. Although the tax consideration was a factor for the timing of the buybacks for these mega corporations, there are other positive elements of share buybacks for both the investors and companies.
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A share buyback, also known as a stock buyback, is a financial strategy used by companies to repurchase their own outstanding shares from existing shareholders. In a share buyback, a company uses its own funds to buy back its shares either on the open market or directly from shareholders.
The goal of a share buyback is to reduce the number of outstanding shares available on the market. By doing so, the remaining shares become more valuable, increasing the value of each shareholder’s stake in the company. Share buybacks can also boost the earnings per share (EPS) by reducing the total number of shares outstanding, which can make the company’s stock more attractive to investors.
When a company buys back its own shares, the cash used to purchase the shares is essentially returned to shareholders indirectly.
Here’s how it works: When a company buys back its own shares, the number of shares outstanding in the market is reduced. This reduction in the number of shares outstanding increases the proportionate ownership of each shareholder who still holds shares in the company. As a result, the value of each share goes up, and shareholders who still own shares benefit from this increase in value. If a shareholder chooses to sell their shares after the buyback, they will receive cash from the sale at the increased share price.
So, while shareholders do not receive cash directly from a stock buyback, they do benefit indirectly from the increase in the value of the remaining shares that occurs as a result of the buyback.
There are a few different ways that a company can carry out a share buyback. One common method is through a tender offer, where the company offers to buy back a specific number of shares at a premium price. Another method is through open-market purchases, where the company buys back shares on the open market like any other investor. Companies can also use a combination of both methods.
Companies implement share buyback programs for a variety of reasons, including:
1. To return cash to shareholders: By buying back its own shares, a company can return excess cash to its shareholders. This can be a tax-efficient way to distribute cash to shareholders, as the cash is returned through the increase in the value of the remaining shares.
2. To signal confidence in the company: When a company buys back its own shares, it sends a signal to investors that it believes its shares are undervalued and that it has confidence in its future growth prospects.
3. To manage capital structure: By reducing the number of shares outstanding, a share buyback can increase the earnings per share and improve the company’s financial ratios.
4. To avoid dilution: Share buybacks can be used to offset the dilution that occurs when a company issues new shares, such as through employee stock options. Dilution refers to the reduction in value of existing shares and the proportionate ownership stake in the company due to the issuance of new shares.
5. To support stock price: Share buybacks can help to support the company’s stock price by reducing the number of shares outstanding and increasing the demand for the remaining shares.
Overall, share buybacks can be an effective tool for companies to manage their capital structure, return cash to shareholders, and signal confidence in their future growth prospects. However, it’s important to note that share buybacks are not always the best use of a company’s cash, and the decision to implement a buyback program should be made based on the company’s specific circumstances and priorities.
President Biden signed a new law to impose a 1% tax on share buybacks in August 2022 that went into effect at the end of December 2022. This new law was created because share buybacks were not being taxed in the current US tax system the way dividends are taxed.
The Federal government is keenly aware of the tax imbalance between dividends and buybacks, which led to the new tax law at the end of 2022. A lot of companies rushed to purchase their shares in 2022 prior to the new tax implementation. Moreover, the Biden Administration does not think this new 1% tax is enough to fix the imbalance and has proposed to raise the buyback tax to 4%. Congress will be discussing taxation on investments for the foreseeable future.
Meta Platforms Inc. is the parent company of Facebook.
Meta announced on February 1, 2023 their adoption of investor-friendly measures, specifically a $40 billion share buyback program and cost-cutting measures aimed at addressing rising competition. After this announcement, Meta saw a significant increase in its stock price, with shares reaching their highest level in almost ten years.
This is an increase from last year’s stock repurchase of nearly $28 billion.
Apple has been reducing its number of outstanding shares through their ongoing repurchase plan.
In the past, Apple has been known for its aggressive share buyback program, which has helped to increase the value of its stock and boost shareholder returns. As of November 2022, Apple had bought back more than $550 billion worth of its own stock since the program was first authorized in 1986.
As for Apple’s future stance on share buybacks, investors will have a better idea in April when the company usually adds more money to its repurchase authorization. Despite the global impact of the pandemic, Apple has continued to generate strong earnings, which has allowed the company to maintain its cash reserves. Apple’s recent financial results were also positive, and the company was the only mega-cap stock to rally in the aftermath of the earnings report.
Apple’s historical dominance in ‘betting on itself’ has paid off well for both the company and the investors. Apple has outspent its closest rival of stock buybacks by at lease $30 billion in the last 5 years.
Recent reports indicate that Alphabet Inc., the parent company of Google and YouTube, has been actively buying back its own shares. Alphabet’s commitment to share buybacks is evident, with the company spending over $100 billion on repurchases in the past two years.
According to data from YCharts, Alphabet has bought back at least $15 billion worth of shares in each of the past three reported quarters. Alphabet Inc. repurchased about $90 billion in 2022.
Like many mega corporations, its stock price peaked after the pandemic in November 2021, and then it steadily decreased in 2022. Timing was good for Alphabet to execute a large repurchase in 2022 when stock price was low and seemingly undervalued.
The chart below, taken from Microsoft’s Investor Relations page, shows how Microsoft has historically returned cash to shareholders through total dividends and share buybacks. Follow the light blue line indicating the growth of dividends per share over the past 5 years.
Share buybacks can increase the dividends per share to the shareholder in two ways:
By reducing the number of shares outstanding, share buybacks can increase the earnings per share (EPS) of the company. This is because the company’s total earnings are divided among a smaller number of shares, resulting in a higher EPS. When the company pays dividends to shareholders, the dividends are typically paid out on a per-share basis. So, if the EPS increases due to a share buyback, the dividends paid out to each shareholder may also increase.
Share buybacks can also increase the dividends per share by signaling to the market that the company has excess cash and is willing to return it to shareholders. This can boost investor confidence in the company’s financial health and future prospects, leading to an increase in demand for the company’s shares and potentially driving up the share price. As the share price increases, the dividends paid out on each share may also increase.
Microsoft seems to be continuing this trend going forward. For Microsoft, a stable mega-company, utilizing a repurchase plan makes it easier to remain in control of their stocks. Having fewer outstanding shares prevents others from taking a controlling stake in the company.
Summary
Monitoring a company’s history of share repurchases can be a useful tool for investors, as it is generally seen as a positive sign when a company buys back its own shares. It shows that the company has confidence in its future performance and is betting on itself over all other investments it could make with the cash on hand.
It’s important to note that plans for share buybacks and other financial strategies are subject to change based on market conditions and other factors. As financial advisors, we will be monitoring these mega corporations’ financial reports and other announcements for updates on the company’s plans for share buybacks in the coming years.
Sources:
Important Note: These are not to be considered as recommendations, rather given as examples for discussion purposes only.
https://www.microsoft.com/en-us/Investor/earnings/trended/cash-returned.aspx
https://investorplace.com/2023/02/alphabet-is-snapping-up-goog-stock-should-you/
https://www.wsj.com/articles/meta-platforms-shares-surge-on-cost-cuts-stock-buyback-11675365856
https://www.bloomberg.com/news/articles/2022-11-29/apple-aapl-stock-buyback-bonanza-helps-to-buoy-stock-in-market-slump
https://chat.openai.com/chat/