Corporate America is flush with cash and buying back a near record amount of stock this year. President Biden wants to increase the taxes on those buybacks. Biden will reportedly propose in his State of the Union speech tonight to lift the tax companies pay when they buy back their own stock, to 4% from 1%. The theory is that imposing additional taxes on buybacks will encourage companies to invest in hiring more people or make capital expenditures (more plants, buildings, or technology) rather than repurchase their own stock. While the validity of that theory is debatable, there’s no doubt companies appear to be embarking on a buyback spree. Many observers anticipate 2024 could be a near-record year for buybacks. Why buybacks are ramping up After a record 2022, when $950 billion in stock was bought back, 2023 was a disappointing year, due largely to a lack of earnings growth. But 2024 and 2025 are looking like near-records. Buybacks: ramping up? (executed buybacks) 2024 (est.) $925 b. 2023 $815 b. 2022 $950 b. 2021 $919 b. 2020 $538 b. 2019 $749 b. Source: Goldman Sachs Jeffrey Yale Rubin at Birinyi Associates estimates that there companies announced $187 billion in buybacks in February alone, second only to the record of $225 billion announced in February 2022. “Solid earnings growth will be the primary tailwind to buybacks while elevated valuations and policy uncertainty will be headwinds,” Goldman Sachs said in a recent report. Goldman recently raised its 2024 buyback forecast to $925 billion (up 13% year-over-year) and $1.075 trillion in 2025 (up 16% year-over-year). Goldman noted that a good chunk of the buybacks are being driven by record profits in big tech: “We expect buyback growth in 2024 will be driven largely by the mega-cap tech stocks,” the bank said. Indeed, Goldman noted that the Magnificent 7 by themselves accounted for 26% of S & P 500 repurchases in 2023. Corporations prefer stock buybacks Corporate America has wide latitude on what it does with the cash flow it generates. Excess cash will typically fall into three buckets: buybacks, dividends and capital expenditures. While the percentage that goes to each bucket ebbs and flows, companies have recently shown a greater penchant for buybacks. 2023: What corporate America did with its cash flow Buybacks $765 b. Capital expenditures $597 b. Dividends $588 b. Source: S & P Global The reason: buybacks can boost share prices because they reduce shares outstanding and, in theory, improve earnings per share. Of course, dividends are an alternative source of returning shareholder money. And big tech companies may be moving in that direction. At the same time it announced a recent buyback, Instagram-parent Meta Platforms also declared its first ever dividend. Three of the Magnificent 7 (Alphabet, Amazon, and Tesla) don’t pay any dividend. Goldman found that large companies with stable earnings, high profit margins and cheap valuations are the most likely to initiate dividends. Using this framework, they noted that Alphabet and Amazon respectively rank as the 1st and 8th most likely stocks in the Russell 3000 Index to start paying a dividend. Diverting cash to capex and hiring an open question It’s possible that companies will divert spare cash into increased capital spending and stepped-up hiring if buyback taxes go higher but, at least for big-cap tech stocks, the decision is more likely driven by the state of technological growth, not tax avoidance. The Magnificent 7 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 capex and R & D spending. “If management teams see attractive investment opportunities beyond this growth in spend, they may limit growth in buyback programs in order to fund investment,” Goldman said. Elsewhere, much of the decision to invest in one bucket or another boils down to economic growth: higher growth means companies will be more willing to invest in hiring more people and making capital expenditures. Goldman noted that its economics teams expects economic growth will slow in the second half of 2024, suggesting investors will continue to favor companies that return cash to shareholders. “However, if economic growth momentum instead continues to build, investors may begin to increasingly reward companies that are investing for growth,” Goldman said. Would higher taxes discourage companies from doing buybacks? In early February, Meta authorized an expanded $50 billion share buyback program , equivalent at that time to roughly 5% of outstanding shares. Under the current tax, the company would pay $500 million, under Biden’s proposed tax, it would rise to $2 billion. That is a significant amount of money, but it’s not clear if it would cause Meta to divert money from buybacks to capital investment. “I haven’t seen anything that would prove taxing buybacks would cause corporations to divert cash to 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 put more money into hiring and capital expenditures if the economy was continuing to grow: “That is what they should be doing, going where the growth is,” he told me.
